In recent weeks, several reporters have called to ask our view concerning how the current economic environment will affect small businesses. In a word, our view is “badly.” Loans will be harder to get, fees (both loan and non-loan) will increase and, overall, many banks will deemphasize their interest in serving small businesses as clients.
 
Small Businesses Suffer Today…
One indication: Financial Week recently reported on a Federal Reserve survey of senior loan officers (taken in October when the economy seemed more stable than today) in which nearly 90% of banks reported increasing their cost of credit to small businesses. Multiple other examples of a deteriorating focus on small business come from speaking to business owners who are increasingly frustrated by what they consider little-to-no support from their banks.

Cutting back in a wholesale fashion on the small business segment is unjustified from either a risk or economic perspective. In fact, banks should be stepping up their focus here; nonetheless, we see a pull-back occurring at many banks. At least three factors drive their apparent “abuse” of and withdrawal from the small business segment:

 

• Senior management’s failure to understand the components of its small business portfolio

 

• Banks view small business as an easy source of fee revenue

 

• Poor senior management sponsorship of the small business effort

 

1.  Senior management’s failure to understand its small business portfolio. Yes, some problems exist within small business loan portfolios. Both Bank of America and American Express have commented publicly about deterioration in their card portfolios. A number of our clients are experiencing increased delinquencies and losses in several industry categories, including construction and trucking. However, many other industries and the vast majority of borrowers are continuing to perform well; delinquency and loss numbers seem under control and do not come close to approaching the deterioration seen in other business segments, such as mortgages and larger commercial real estate loans.

 

While most banks are imitating ostriches, the best are assessing their portfolios to understand where their weak areas are, whether involving specific industries or types of loans; for example, investor (as opposed to owner/occupied) real estate. They are tightening the loan spigot in those areas but continuing to encourage deal flow and, in some cases, heightening their sales focus in areas of continued interest; for example, professionals and deposit-only customers. In particular, community banks and some credit unions are stepping up, building loyalty and taking share from other players who are alienating what should be one of their core customer groups.

 

2.  Banks view small business as an easy source of fee revenue. Small business is an attractive area in which to increase fees. Individual increases are relatively small, but the large number of customers can result in a significant revenue pop. While, as consultants, we have encouraged banks to increase fees (and raise loan pricing), some appear to be going overboard, potentially killing the golden-egg-laying small business goose. Small business owners hate being feed to death.

 

3.  Poor senior management sponsorship of the small business effort. At many banks, small business remains “the red-headed step child,” without the internal clout of other groups such as the middle market or the branch channel. This remains the case despite the high returns (30%-plus) still available from smaller business. Unfortunately, small business remains at an internal power disadvantage at many banks versus other units. Appropriate, no, but the reality, nonetheless. Therefore, small business groups (and by extension their customers) will be at a disadvantage in receiving capital and funding versus other groups.

 

…Banks May Suffer Tomorrow
Banks that abandon, undercut, or abuse their small business customers (and too many are) are going to face repercussions from the government, their competitors, and, ultimately, their small business customers.

 

Appropriately, Congress and governmental agencies are asking more questions about how the banks are using their TARP funds. If you take money from the government, you are now beholden to it; the pressure on banks to lend to small businesses and other “preferred” borrowers will intensify. Banks would be a lot smarter to pick their own focus now before a regulator dictates a focus to them.

 

Competitors that understand the value of the small business customer are actually soliciting prospects. For example, a recent New York Times article reported that while many large banks have reduced the LTV ratio for home equity lines (which many small business owners use to finance seasonal cash flow requirements) to 50 percent, many community banks continue offering this product with an 80 percent LTV. Community banks and credit unions are taking share in the small business space. These are share points and customers that the bigger banks cannot afford to lose.

 

Many of the small businesses owners I know express frustration and anger about their banks. Interestingly, even those needing to borrow believe they have options and they are leaving banks they have been with for years. As one business owner said, “I’m going to leave them before they leave me without the funding I need.”

 

Concluding Thought
Greenwich Research recently stated that 50% of small business customers were shopping for or considering looking for a new bank. That is up from less than one-third a year ago. The message to banks should be clear. Perform or lose one of the most attractive franchises available to your industry.