Furash & Co. recently completed a study of competition in the small-business market. The study was commissioned by the Association of Reserve City Bankers.
The Furash firm also has examined the strategies and implementation techniques used by the small-business organizations of eight banks that are successful in this area.
Cynthia Glassman, author of the study, provided the following dialogue on small-business banking issues.
Q.: Bankers are not saying that their small-business franchises are under attack by nonbank competitors. Why the concern?
GLASSMAN: Our study confirmed firmed the perception that bankers don't see many nonbank competitors going after their customers except in the case of some local small finance companies. The threats are just coming into view and haven't become apparent in the marketplace.
The reason for concern is that the trends now seen in small-business financing are similar to the conditions that existed just before banks began to lose major chunks of their business borrowing to commercial paper, finance companies, foreign banks, and now junk bonds.
The key trends are overregulation, deterioration of the bank funding cost advantage, new technology, securitization, and changes in customer behavior. All these factors are at work in the small-business market, threatening one of the industry's most profitable and, so far, durable franchises.
Q.: Did the survey develop any hard evidence that small-business franchises are diminishing?
GLASSMAN: Not statistically hard. No one collects the data. Data will begin to come out, now that FDICIA mandates that small-business lending be included in the call report.
But there's a lot of anecdotal evidence that the reporting required by regulations is turning small-business owner/managers away from banks to nonbank competitors.
We interviewed senior managers at 16 banking companies of various sizes. They say they want to lend to small businesses because it is profitable. Expanding the franchise is a major strategic objective for most of them.
But when you ask a long-standing customer to pay $3,000 for an appraisal of his plant before you will give him a new loan -- as now required by law -- he doesn't understand why, gets mad, and thinks about finding another source of funds.
If he finds one, it won't be a bank. That's anecdotal, but it's real and it's hard evidence from the marketplace.
My favorite quote from the survey: "If there isn't some relief soon, I think in the next five years nonbanks will capture a significant portion of this market just like they've gotten into the credit card business and eaten into the deposit business. The regulations are simply ridiculously onerous."
Q.: And yet banks are blamed for not lending to small business.
GLASSMAN: That's the irony, of course. Banks are blamed for what is seen as a credit crunch because of the incorrect perception that they are the only lenders to small business.
Q.: Who are the other major lenders?
GLASSMAN: Suppliers' trade credit is a major source of funds for small businesses. Small finance companies are a growing source in some regions.
Nonbank leasing companies dominate the small-business leasing market. There are major nonbank SBA lenders, notably the Money Store with more than $250 million outstanding.
Q.: Some bankers have expressed a concern about the Merrill Lynch Cash Management Account.
GLASSMAN: Yes, it turned up in our survey. Though Merrill has 300,000 small-business clients, few bankers see a threat.
They see Merrill as really only a collateral lender, not able to understand the needs of small businesses, and they think the company has underestimated the risks in the market and will incur big losses in a few years.
On the other hand, a few bankers worried that if Merrill is successful other securities firms will join them and banks will be left with the dregs. This could happen. The strategy of some investment houses is changing from pure underwriting.
Lehman Brothers has begun making conventional bank-type business loans, and Goldman Such is understood to be developing a commercial loan origination business. Of course, these firms have lower regulatory costs than banks.
Interestingly enough, we have seen securities firms hiring commercial bank lenders who have been consolidated out of the banking business in various parts of the country.
Q.: Banks also frequently are charged with taking deposits from some localities but not lending them back. Did the survey uncover any evidence of that.
GLASSMAN: Overwhelmingly, the bankers deny it. Typical responses were: "If we buy into a market, we want to grow in that market. We don't drain the deposits back to the head office." My favorite from this section: "That's nonsense. It doesn't make sense. I know of no case where it's true. We make our money making loans."
Q.: You mentioned securitization as an emerging threat to the bank small business franchise. Those loans are far from standardized. How can they be securitized?
GLASSMAN: Suppose they get a government guarantee? Legislation to provide that was before Congress last year and has been reintroduced.
Granted, it may take awhile, but Velda Sue -- Venture Enhancement and Loan Development Administration for Small Undercapitalized Enterprises -- has some strong support.
Securitization is the most dangerous long-term threat we see. It would split origination from holding the loans. A few banks, those that can become major originators, will benefit.
The large majority will find a major new competition in the market from institutions that can originate but not hold loans.
Furthermore, one of a bank's major advantages in making small-business loans is its expertise in underwriting. The government guarantee would wash that advantage completely away.
Banks have not fared well in credit card securitization. Their share of revolving credit dropped from 66% to 54% from i989 to 1992, while securitized asset pools jumped from 12% to 29%. We believe the same thing would happen in their small-business franchises.
Q.: The damage that overregulation does to the banks' ability to make small-business loans is obvious, they slow decision-making, increase the hassle factor, and make the customer think about going to a less regulated lender. But surely the cost-of-funds advantage provided by the checking account isn't going away.
GLASSMAN: It will be weakened, though. The new element at work here is that a new generation of small-business owner /managers is comfortable with new technology that enables them to manage their cash efficiently.
This inevitably will cut bank demand deposit balances. If they take their lending business out of the bank, reacting to the hassle problem for example, the demand deposit balances certainly will be kept to the minimum.
Q.: You mentioned small finance companies as an alternative to banks for some small-business owner/managers.
GLASSMAN: In some parts of the country, bankers are finding them increasingly competitive Their strength is underwriting in specific niches, for example inventory financing, accounts receivable or specialized types of equipment.
They have good risk management capability. They get to know their customers, provide stability and in many ways do the things bankers used to do before the regulators made them wary of lending to growing businesses.
Q.: What recommendations did you suggest to the Reserve City Bankers as a result of your findings?
GLASSMAN: No one has to urge any Washington bankers association to fight overregulation, but it is the major current threat to the industry's small-business franchise. As for future threats, the industry should do everything it can to block any legislation that would lead to the securitization of small-business loans.
A strong argument against Velda Sue initiatives in Congress right now, with the S&L disaster fresh on everyone's mind, is that government guarantees of small-business loan securities would place an enormous potential liability on the taxpayers.
Also, bank associations should demand that more information on the small-business lending activities of nonbanks be gathered and published. Until the perception that they are the only lenders in the market is corrected, bankers will continue to take the heat for credit crunches, inadequate lending to minority small businesses and over CRA responsibilities.
Q.: Can the small business franchise be saved?
GLASSMAN: Banks still have the franchise and its advantages, though those are eroding. Many of the bankers in our survey said they recognize that they are not organized to make the most of their small-business opportunities.
