When Spencer Witty and James Lawrence start talking about what their business customers do, there's no stopping them.

Lingerie, wading pools, light bulbs, door hinges, even a smoked- fish curer just scratch the surface.

"We do everything New York does," said Mr. Lawrence, president and chief executive of Merchants Bank of New York, gesturing around his Fifth Avenue office at various objects. "Every single thing you're wearing."

The 113-year-old Merchants has passed over millions of customers in New York, profiting instead from its extensive customer base of small businesses throughout midtown and lower Manhattan.

Through its seven Manhattan branches, it loans an average of $1 million to $2 million to these middle-market entrepreneurs, most of which report sales of $1 million to $200 million.

Its efforts have placed Merchants fifth nationally among small business lenders with less than $1 billion of assets, according to an American Banker survey. As of June 30, Merchants had $131 million in small business loan, which makes up nearly half of the bank's total loans.

Merchants even has an international finance department to handle letters of credit and foreign collections in 120 countries for its import customers. The bank can issue a letter of credit within 36 hours.

And while most banks are still cleaning up from the early 1990s real estate crunch, and reeling from this year's interest-rate hikes, Merchants is gearing up for one of its best years ever.

Earnings for the first nine months of the year were a record $8.6 million. And the bank's success has caught the attention of its competitors.

"We have a very high regard for them," said John C. Millman, president and chief executive of $640 million-asset Sterling Bancorp.

Since it was founded in 1881, Merchants has catered exclusively to medium-sized, usually private businesses, preferring to avoid retail banking so it won't have to compete with the larger institutions. "It's impossible to compete with the Citibanks and Chemicals of this world," Mr. Lawrence said. "We can't be all things to all people and we don't want to, either."

But Merchants' strength in small business loans also presents a challenge, as the New York City economy still lags the national recovery. Unemployment in the metropolitan area remains 15% to 20% higher than the national average.

The uncertainty about the region's economy has kept the bank's customers from borrowing too much and the sagging loan demand has created more competition with larger banks for the middle-market customers.

As a result, the bank's loan volume dropped to $290 million in the third quarter from $328 million in September 1993, forcing Merchants officials to work harder to find more customers.

This is where Merchants' strategy works best. The bank's success stems from its close ties with both its business customers and the "professional fraternity" of accountants, attorneys, and investment bankers.

"We're like a country bank in the center of the Big Apple," said Mr. Witty, chairman of the midtown Manhattan-based company.

The bank relies on referrals from both groups to expand its customer base, eschewing the more complex investment products offered by large bank competitors.

"If you handle people well and they're happy customers, they'll refer other unhappy customers from other banks," Mr. Lawrence said. "Our best salesmen are the big banks. They change offices all the time."

In fact, the two executives make themselves available to speak with any customer at any time, even answering their own phones and meeting with loan applicants personally over lunch.

"The better you understand a client's business, the better the banker you will be for them," said Mr. Lawrence. "The numbers are important, but it's the people who pay you back."

Loans are frequently approved the same day, even within an hour, after a review process that often includes an on-site inspection and advice from Mr. Witty and Mr. Lawrence.

"They don't give money easily, but once they understand what you're going to do with it and why, there isn't any problem," said Erwin Pearl, owner of costume jewelry maker Erwin Pearl Inc. and a customer for 30 years.

For one applicant, the two-man executive team went to a warehouse filled with boxes stacked almost to the 20-foot-high ceiling. Mr. Lawrence said he asked one of the workmen to bring down a box from atop one of the stacks so he could "heft it" to ensure it wasn't empty.

"There's a great deal of personal attention from the staff to the clients, at all levels," said Arya Momeni, vice president of rug importer Momeni Inc., a Merchants customer for almost 20 years.

But Merchants has also pledged to stick to its strict, plain- vanilla lending standards, which kept it out of trouble when other banks' loans went sour during the recession.

That means the bank won't offer more flexible terms or cheaper rates to woo customers, who say they still prefer the bank's personal service to a larger bank's corporate structure.

"You get an answer," said Howard Bloom, owner of Chetta B. Inc., a women's clothing manufacturer in New York, a customer for eight years. "It's not one of these big banks where you get jerked around all the time."

The bank will not loan more than about $8 million, or 10% of its capital, to any single customer, never approaching its legal lending limit of $12 million.

And by adhering to that very conservative loan policy, the bank has kept its eye on growing the bottom line while minimizing risks.

In fact, with a Tier 1 capital ratio of almost 21% and loan loss reserves almost three times its $2 million in nonperforming loans, Merchants has been rated one of the safest banks in the country by Veribanc Inc. of Wakefield, Mass., and Bauer Financial Reports Inc. of Coral Gables, Fla., two national bank-rating firms.

Merchants is profiting from what Mr. Witty calls the bank's "debt-free fortress balance sheet," designed to make money when interest rates rise. About 25% of its deposits are in noninterest- bearing checking accounts, providing a cheap source of funds, and most of its loans are floating rate.

Seasonal short-term borrowings from 15 correspondent banks or through repurchase agreements are kept to a minimum.

Merchants has also kept overhead costs low, maintaining an efficiency ratio of about 44%.

But the conservative bank is ready to take its strategy on the acquisition road following its first purchase in late 1992 of $400 million in deposits from First New York Bank for Business.

The bank also set up its holding company, Merchants New York Bancorp, in July 1993, after realizing that federal regulations permitted only a bank holding company, not just a bank, to acquire failed thrifts.

But officials remained focused on their strategy.

"We would like to be where we could manage it," Mr. Witty said. "Absentee management is what the other banks have."

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