JACKSONVILLE, Fla. -- Donna and Mark Christensen initially resisted when a Barnett Banks Inc, branch manager sought to lure them away from a competing bank.

The owners of Flow-Technology, a distributor of high-end plumbing fixtures with $3 million in annual sales, were relatively satisfied with First Union Corp. But Barnett manager Jacqueline Franco made repeated visits to tout the advantages of Barnett's new small business lending program.

It was restrictive loan covenants that finally swayed the Christensens in favor of Barnett - First Union imposed them; Barnett didn't. "It made us start questioning our other institution and how we had been treated," says Donna Christensen, Flow-Technology's president. The fact that Barnett offered a slightly better rate clinched the deal.

Ms. Franco's hard-fought victory suggests Jacksonville-based Barnett is making some progress in its small business lending effort, which was unveiled with much fanfare two years ago. But the struggle for How-TechnolOgy'S account also illustrates the difficulties of small-business lending: it takes time and requires a lot of personal effort.

'Holy Grail'

"This is not a picnic," says Douglas K. Freeman, Barnett's chief corporate banking executive. "There are very few people you can look at who have done this business right.

"Everybody wants to, and thinks this is the holy grail and the next big advance in commercial banking. But there are going to be some very distinct winners and losers coming out of this strategy."

Barnett, the nation's 21st-largest bank, is working hard to be one of the winners. The Jacksonville-based company hired Mr. Freeman away from Wells Fargo & Co., San Francisco, in August 1991 to mastermind the push and gave Steven D. Hickman operational control as director of small business banking.

Mr. Hickman's division, also based in Jacksonville, provides centralized underwriting for small business loans made from Barnett's 621 branches in Florida and Georgia. The unit has designed and introduced loan, deposit and cash management products tailored for small business.

It's an industrywide trend. Stung by the commercial real estate debacle of the early 1990s, banks have increasingly fixed upon small business as an alternative source of loan growth. Banks responding to a recent survey by the KPMG consulting firm said they expected loan growth this year to come primarily from small business, middle market, and consumer lending.

Banks that have announced major small business programs, in the last year or so include Barnett; Bank of Boston Corp. Shawmut National Corp., Hartford, Conn.; BankAmerica Corp., San Francisco; Nations. Bank Corp., Charlotte, N.C. and just last month, First Union Corp., also of Charlotte.

Barnett's effort is particularly high profile given the dominant role small business plays in the Florida economy. Barnett estimates there are more than one million small businesses, defined as companies with sales under $5 million, located in the territory it covers.

The bank was making too much money from retail customers and commercial real estate in the 1980s to pay much attention to small business. It was only after commercial realty crashed in 1990 that the bank took another look.

Going After Share

What Barnett realized is that it had banking relationships with 42% of Florida companies with sales over $50 million, but only 11% of those under $5 million in sales. Its goal now is to get that small-business market share up to 25% by 1997.

The effort is expected to help Barnett realize a parallel goal of boosting noninterest income as a percentage of revenues from 26% to more than 30% within that period.

It would seem to be a nobrainer. What could be more natural than banks making small business loans? The market includes 98% of the 20 million companies in the U.S which generate more than 40% of the gross domestic product, and create jobs at more than twice the rate of larger companies.

The problem is cost. Oliver, Wyman & Co., a New Yorkbased consulting firm, estimates it costs $3.20 per $100 of loan to make and monitor a small-business credit - 10 times the cost of a large corporate loan.

'Dramatically Overserviced'

"Small-business loans are dealt with in a corporate banking context very much in the same way as if they were middle market or large corporate they're dramatically overserviced," says managing partner Alex Oliver. "Too much time is spent on the origination, on all the credit approvals, and then on the ongoing monitoring of he accounts."

One of Barnett's solutions is to stop spending so much time on that monitoring. To begin with, Barnett lenders are asked to focus on businesses that have demonstrated, statistically, they can be underwritten in a cost effective manner. This list includes wholesalers, retailers, disributors, manufacturers and professional service providers, such as attorneys and phyicians.

It does not include contracers or real estate developers, those projects must be continually monitored. For the smallbusiness loans it does write, Barnett doesn't include all the traditional covenants that bothred the Christensens, such as net worth and cash flow requirements.

"When you're involved with convenants, you have to monitor that stuff- otherwise why have it?" Mr. Hickman says. "If you get a car loan, do they call you annually for financing statements? So why should we do that for very small business loans?"

Seeking Soundness

At the root of Barnett's approach is the conviction that small-business loans of the size Barnett is interested in - those under $50,000 - should behave very much like consumer loans.

But First Union doesn't buy that argument. The company is still underwriting small-business loans "with the same basic credit philosophy that we've had in the past," says Ben Maffitt 3d, head of First Union's commercial bank group.

"We are probably placing less in terms of loan agreements and restrictive covenants and things like that than you might see in a larger loan. But we want the loan to be sound on the front end."

The conflicting philosophies of Barnett and First Union illustrate a conundrum of smallbusiness banking: Should it be considered a corporate or retail operation? As Mr. Freeman says, "It's like the centaur out of ancient Rome - half man, half horse.

"Our concept is that small business really is a process-oriented business and more of a retailing-oriented business than a corporate business."

Barnett executives liken small-business lending to credit cards, where extremely high volume makes up for high delinquencies. "This portfolio will probably be the second riskiest portfolio in the bank behind charge cards," Mr. Freeman says.

"We have a hypothesis that the law of large numbers prevails in assessing risk in smallbusiness portfolios. If we're wrong, it's going to cost us some money."

Consultants who have studied the economics of small business lending tend to line up on Mr. Freeman's side. "The cost of doing small-business lending is so much greater than the statistical expectation of loss from the business by a factor of about four to one," Mr. Oliver says.

Incentives

To reduce costs, Barnett has tried to use the fixed investment already sunk in its branch network. While many banks have formed separate lending units to solicit small-business prospects, Barnett has offered incentives to its branch managers to make the effort, backing them up with centralized underwriting and product support.

Ms. Franco, 32, who manages the Barnett branch near Jacksonville's Regency Square shopping mall, says the main difference she's noticed since Barnett introduced its program in May 1992 is that she no longer gets bogged down in paperwork. "I can spend all my time now prospecting, working on deals, trying to get new deals and keeping the customers we have satisfied," she says.

Like others in the industry, Barnett is also looking at credit scoring. Banks will be able to lower their costs substantially if they can automate the underwriting process for small busi- ness loans in the same way they do now for credit cards.

Barnett has just begun using credit scoring for small business in a pilot project and will be testing the system for the rest of the year. "I anticipate us being pret- ty much of a scoring shop by 1995," Mr. Hickman says.

More than Loans

All the experts agree that successful small-business banking depends on selling more than just loans. In the past year, Barnett has introduced a wide range of products for small business, including "Superpay," a payroll processing and tax filing system; "Small Business Commercial Mortgage," which provides 15year, fixed rate mortgage financing to owner-occupied businesses; and a credit card that allows proprietors access to both their business and personal accounts at ATMs with a revolving line of credit of up to $50,000.

Barnett, like other banks, puts particular stress on encouraging small-business customers to keep their deposits parked at a branch. "A lot of the profitability of the small business customer comes from the deposit side. They tend to hold more deposits at the bank relative to the loans than the larger commercial customers do," says consultant Cynthia Glassman, managing director of Furash & Co. in Washington.

To date, the only information Barnett has publicly disclosed about its small-business lending operation came in the first quarter 10-Q. In this regulatory filing, Barnett said the program "generated $137 million in new loans during the quarter, in addition to $66 million in commitments."

That's a drop in the bucket for Barnetts total commercial portfolio, which stands at $4.1 billion, suggesting the program has a long way to go before it has a measurable impact on the company's performance.

Mr. Freeman and Mr. Hickman decline to elaborate except to say the amount of small business loans in the second quarter will be higher than the first. The operation "is profitable today," Mr. Hickman says. "But it's not as profitable as it will be later."

Against the Tide: Loan Strategy Rdies on Branch System

Making a virtue of necessity, Barnett Banks Inc. decided to base its smallbusiness banking program in its branch system. Barnett has 603 offices in Florida, more than any other bank in the state, so it was only natural for it to leverage off this fixed investment.

"If we had 10 branches, we wouldn't be working with a branch-based distribution, system," says chief banking executive Douglas K. Freeman. "You have to play the hand you're dealt."

But Barnett's strategy - in which branch managers make small-business loans within their own territory - runs counter to the dominant trend in the industry, which is to establish small-business banking units that are separate from the branch-based retail network. Using this method, sometimes referred to as a the "hub and spoke" system, specialist lenders cover a wide geographic area, possibly one or more states, from a few regional centers that utilize centralized underwriting.

Hub-and-Spoke Method

NationsBank Corp. and First Union Corp., the two largest banks in the Southeast, both use the hub-and-spoke method. First Union, which announced its small-business program in May, plans to base 50 lenders in each of two centers, Charlotte and Tampa, to cover its entire seven-state region. First Union branches will function as referral points for the two centers.

"Branch managers are typically very busy. They have a lot of things on their plate," says Ben Maffitt 3d, head of First Union's commercial bank group. "We decided that having a dedicated unit was more efficient."

Barnett executives admit that motivating their branch managers is the greatest obstacle they have faced in their small-business program. "We've got mutual funds we're trying to sell through the branches, we've got annuities, we've got deposit products - all the myriad retail side products - and we're also trying to push small business through this conduit," says Steven D. Hickman, Barnett's director of smallbusiness banking, under Mr. Freeman.

To lessen the burden on branch employees, Barnett backstops its smallbusiness lenders with centralized underwriting and loan documentation.

The type of small-business banking now practiced by large banks is essentially in its infancy, so only time will tell whether the branch system or the hub and spoke method delivers the best resuits. "We don't think there's a right or wrong way," says consultant Cynthia Glassman, with Furash & Co. in Washington. "There are tradeoffs in each.

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