Fast-growing small companies are shunning bank loans and turning to do- it-yourself finance, a new study shows.
The companies are shying away from the loan market despite attractive interest rates and favorable terms, according to a study by Coopers & Lybrand LLP.
Only 24% of the companies studied were seeking bank loans in the fourth quarter of 1997,down from 34% two years earlier; it was the lowest rate since the survey was begun in 1991. The study focused on booming U.S. companies with annual revenues of less than $50 million.
The study suggests that the companies aren't necessarily using alternative funding sources to pay for expansion. Rather, the strong economy is allowing them to self-finance growth.
"There seems to be a coincidence with better margins and the need for less financing," said Pete Collins, an analyst at Coopers & Lybrand.
That has put the squeeze on banks lending to such small-capitalization companies.
Tom Denison, head of BankAmerica's Midwest lending, said the study supports what he has been hearing from his customers: "We'll do it ourselves."
The study found that 36% of companies reported an increase in profit margins in the fourth quarter of 1997, compared with 33% a year earlier. Companies reporting increases outnumbered companies reporting slimmer margins by nearly 3 to 1. That was far better than the year before, when the ratio was less than 2 to 1, the study said.
But lenders say they aren't worried about the trend. After all, the economy runs in cycles; margins shrink; and the types of financing available to small companies remains limited.
"We know smaller companies aren't going anywhere else," Mr. Denison said. "They don't qualify for other forms of financing. To do any kind of public debt, you really need $50 million to $75 million."
At the same time, borrowing has become far more attractive. The average interest rate for new bank loans declined by 10 basis points in the fourth quarter, to an average of 9.24%-despite a 25-basis-point rise in the prime rate last year.
The study also found that companies negotiating new rates paid even less, about 8.93%-or 31 basis points below average-and that bigger companies won even better terms.
Jim Connolly, head of the Massachusetts middle-market lending group at Fleet Bank in Boston, said the problem for bank lending is greater among companies with annual revenues of $50 million to $150 million.
"We just haven't seen smaller companies going other places," Mr. Connolly said. "Alternative funding isn't a threat" among companies with less than $50 million of revenues.
To offset the loss of business among larger companies, however, Fleet has expanded its own alternative products department. The company moved to expand that staff in 1995.
When lending tailed off a year ago, Fleet expanded further into such products as private placements, public offerings, and corporate bonds. To help its lending group, Fleet began to push a line of fixed-rate products.
"A lot of people saw this coming," he said of the trend away from lending.
Still, lenders agree that small companies will remain a strong market in the future. They also point out that companies in booming industries such as technology still depend heavily on lending, a view supported by the survey. It found that 27% of high-tech companies sought bank loans, compared with only 20% of nontech firms.
Even in the nontech sector, a bank loan "makes it easy to do an acquisition, open a new warehouse or plant," Mr. Connolly said. "Though I don't see them making up reasons to borrow, when they do borrow they're clearly trying to put in long-term contracts. And they're successful."