Where the money is: A small business lending gap
SPECIAL REPORT: THE STATE OF SMALL BUSINESS
March 3, 2017

Martine Rostan had won a new contract.

Her company, Silver Spring-based Professional Business Interiors LLC, has helped firms pick furniture and lay out their new offices for more than 20 years. She needed a loan to purchase furniture as her latest client, a federal agency, would only pay once the contract was fulfilled.

So, she went to an online lender, Fundation. In her experience, traditional banks took too long to get back to her, and their answer might have been no. In that time, the client may have taken its business elsewhere. The Fundation dollars took just a few days.

“You only can get funding when you get the order,” Rostan said. “And when you get the order, you don’t have time to go to a bank for funding.”

She’s encountered online lenders that were less than clear about their loans or charged exorbitant rates. Fundation, she said, was transparent about both, and she walked away happy.

It’s a growing sentiment. In recent years, Greater Washington has seen a wave of community banking consolidation — conditions that could spell trouble for small businesses looking for loans at lower rates than those charged at national bank brands. It’s caused smaller businesses to increasingly turn to alternative financing, including equity sales and online lenders such as New York-based Fundation.

At the heart of this is the wave of banking industry consolidation.

In 1992, there were 11,463 banks across America, according to the Federal Deposit Insurance Corp. That shrunk more than half to 5,170 by 2016. Locally, there were 70 banks headquartered in the region in 1999. That was halved to 36 last year.

Much of the consolidation can be attributed to survival and better prospects for growth, especially thanks to increased regulations since the Great Recession that industry leaders say have weighed more heavily on smaller banks with fewer resources. Many banks retrenched a bit in the wake of the financial crisis, while others have since been absorbed.

And small business loan amounts, at least in Greater Washington, dipped last year. Banks loaned $290 million to small businesses in fiscal 2015, but that slipped to $240 million in fiscal 2016, according to the Small Business Administration. That was lower than fiscal years 2012 and 2013.

As banks become larger, the amount of overhead needed for each loan is the same regardless of the loan’s size, which means the banks gravitate toward larger loans, according to Sam Graziano, CEO of Fundation.

Fundation is a direct lender that partners with banks to provide the small business loans the banks cannot or are unable to do themselves, Graziano said. Banks often refer borrowers to Fundation, which can make the loans while keeping that small business customer at the partner bank.

While banks meet about 90 percent of the demand for small business loans from $250,000 to $500,000, they fall short on the smaller loans, according to Graziano. There is about $80 billion in demand for small business loans less than $250,000, and banks only fill about $52 billion, he added. Three-quarters of Fundation’s loans are for $150,000 or less, he said.

Another factor that could have slowed small business lending is the historically low interest rates that have lasted for prolonged periods. They make the profit margins on small business loans razor thin, making banks even more hesitant to lend nowadays.

“It’s rarely, if ever, because they don’t want to,” Graziano said. “It’s always been a challenging thing for banks to do small business loans.”

And yet, demand grows

He said the problem hits the youngest businesses the hardest.

Those without a long-term credit profile or those in service industries, such as restaurants, construction, florists or even nail salons, might fail a typical bank underwriting test. But some online lenders use their own private capital, which comes with a different level of underwriting. Fundation said it tries to provide transparent  loan terms so businesses know what they're paying across the loan's lifetime.

“There is a really broad ecosystem of companies that are trying to serve the unmet need for capital from the small business market,” Graziano said.

Another funding source has been peer-to-peer lending and other digital lenders that are targeting equity in a business — much like the venture capital community, but on a smaller, more informal scale, said Anirban Basu, economic consultant and CEO of the Sage Policy Group. Essentially, small businesses can get funding by giving up a portion of the equity in their business.

“It’s not so much about lending to these emerging businesses. It’s taking an equity stake in them — and not debt,” Basu said. “You are buying into an idea.”

But Basu also thinks community banks are doubling down on efforts to build up their small business lending. The current loan crunch in that niche, he said, is mostly a holdover from the financial crisis, and small banks are now trying to diversify their portfolios.

“Many banks are working very hard to migrate their loan portfolio from real estate toward commercial lending,” he said. “And many banks want to be aligned with a rapidly growing businesses.”

That goes for a few larger banks, too, who remained some of the region's top small business lenders in 2016. Brian Smith, vice president of small business lending at Capital One Financial Corp., said the company has created an online loan application system where it aims to return an answer to small business owners within 24 hours, though some questions can take up to 72 hours.

“The big thing that we found is that many small business owners care how long it takes to get an answer as the absolute criteria,” Smith said. “We are trying to address that situation. We are trying to make it easier.”

 

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