WASHINGTON - Small-business lending is one of the more profitable services community banks can offer, according to a study released recently by the Small Business Administration.
The SBA's Office of Advocacy analyzed June 1994 call report data and found that for banks with less than $300 million of assets, higher concentrations of small-business loans brought higher rates of return to shareholders.
"Bankers need to be made more aware that lending to small firms is as profitable, or even more profitable, than any other banking service they could provide," said Jere W. Glover, the agency's chief counsel for advocacy.
The finding came as no surprise to R. Michael Menzies, chief executive of $75 million-asset First Bank of Frederick, Md.
"Small-business loans are profitable because they're relationship-based credit," Mr. Menzies said. "The loans become even more profitable over time because the credit risk decreases and your relationship with the small business grows."
However, most of the study's rosiest conclusions on increased bank profits were not adjusted for risk, according to Mike ter Maat, senior economist at the American Bankers Association.
"Looking at bank profitability before adjusting for risk is nonsensical," Mr. ter Maat said. "It's like looking at income before figuring in your expenses."
Nevertheless, when the study's authors added various risks into the equation, small-business loans made by banks with less than $300 million of assets were on average at least as profitable as other assets.
"That is a very important conclusion," said James Kolari, a finance professor at Texas A&M University who was a coauthor of the study. "Banks are getting compensated for the risks they are taking. After adjusting for risk, the rate of return is appropriate."
Mr. ter Maat did say the SBA study backs up other research that found small banks are better at small-business lending than bigger banks.
"The study found that it's like most every other line of competitive business," Mr. ter Maat said. "You have to do it well to make a profit, and community banks do it well."
The study defined small-business loans as all commercial loans of less than $250,000. The 10,542 banks studied were divided into five groups according to asset size, ranging from banks with less than $100 million of assets to those with more than $3 billion.
The SBA also found that banks in the largest category did not profit from making small-business loans, in part because they are not as experienced in this sector.
"It's good business for at least all but the biggest banks," Mr. ter Maat said.
He added that the study brings home the importance of reducing regulatory burdens on small banks. The profits bankers earn on small- business loans can easily be erased by compliance costs.
"It's a delicate balance," Mr. ter Maat said. "It's easy to see how something that erodes margins the way burdensome regulatory requirements do can alter the profitability of these loans."
Regulators started requiring banks to report small-business and small- farm loans in June 1993.