Executive Summary: The small business segment offers banks a significant growth opportunity that is both organic and addresses the needs of the local community. However, this time as banks refocus on this group, they need to avoid falling into their own ways, becoming product pushers rather than broader service providers.

 

 

A web seminar for bankers, currently being promoted, titles itself: “Small Business-An Avenue for Lending Growth.” The description of the event says that “economic and political events have pushed small business lending to the forefront” and that focusing on small business lending has increased in attractiveness as the opportunities in commercial real estate (CRE) and consumer lending decline. The marketing piece then lists several components of the webinar, all of which focus on aspects of lending. The promotion does not include any mention of deposit generation, cash management, investments, private banking, or any other fee-based product.

 

Slow growth for small business lending is likely. Of course, small business offers an attractive lending opportunity for those banks that segment their approaches and develop a rigorous approach to the area, one that leverages technology while effectively exploiting a bank’s knowledge of its community and region. And, in fact, lending to non-financial businesses, including small business, has been down; 2009 flow of funds data shows that these loans decreased by $326 billion last year. A recent Financial Times article (from which I stole the title of this column) underscores the financing approach used by small businesses: “The nine-tenths of U.S. companies with fewer than 20 staff tend to rely on bank credit for funding. Half of such lending is by local banks with less than $10billion in assets.”

 

However, a mass move by the banking industry from areas like to CRE to small business is likely to lead to bad lending and the same bad performance in quality and returns as occurred in CRE. As the Financial Times also mentions, the smaller banks mentioned above are “precisely those institutions struggling with ailing commercial real estate loans.”

 

That same Financial Times article provides a different slant on the needs of small businesses, based upon its interpretation of a Federal Reserve Bank of Atlanta survey of small business lending needs in the Southeast. As it states, “The April poll of 311 small business enterprises suggests the problem lies with demand: only 11 per cent of the respondents cited the unwillingness of banks to lend as an obstacle to obtaining credit. Far more important were weak sales, existing large debts or poor credit scores – the natural consequence of a boom followed by a long bust. Exclude construction and real estate and almost half the sample saw no obstacles to obtaining credit.”

 

A just released survey from the National Federation of Independent Businesses (NFIB) reports the second straight month of increased confidence on the part of small business owners, but as the report goes on, “job creation and capital expenditure plans barely gained and remained at recession levels.” Obviously, borrowing to finance growth plans is unlikely to increase in the face of owner hesitancy to hire and expand.

 

Similarly, the Financial Times article mentioned above promotes the view that small business credit growth will be slow, in part because of understandable reticence on the part of small businesses to borrow. Well-managed small businesses will keep debt as low as possible in light of continued volatility in their operating environment. The FT suggests that we need to look at global trends to recognize what may be happening in the U.S.: “Bank lending dried up in Japan after the bubble burst and it remains weak, as companies pay down debt rather than amass more. Demand for credit from European businesses and house buyers dropped in the first quarter. The problem appears not to be a failure to lend, but rather the large stacks of existing debt that continue to weigh on consumption.”

 

But banks can achieve great growth from the small business segment. Our view is that a bank that pegs its interest in the small business segment on lending is making a basic mistake:

 

– Many, if not most, small businesses do not borrow
– Owners today are being conservative in borrowing, as they should be
– Good small business portfolios self-fund several times over; deposit gathering needs to be emphasized
– The cost of lending to small businesses will become more expensive going forward

 

This last point is one that merits some consideration. Certainly in the near term, we expect less reliance on credit scoring than in the past. Banks will want to “touch” each borrower and the degree of touch will be greater than in the recent past. Many banks will find that, unless they capture a small business relationship, lending will be marginally profitable, if at all.

 

Capture the small business relationship, not the loan. Banks need to understand that the small business customer’s attractiveness rests on capturing multiple aspects of his/her financial services relationship, only one aspect of which is the loan. This truth is fundamental; however, it is typically given lip service by most banks. Banks need to consider building a checklist that they use when evaluating their small business relationship focus. Elements of that checklist include:

 

– Owner deposits
– Owner investments
– Business DDA
– Cash management
– Business retirement accounts

 

Notice that lending is not included above, only because it is usually product number one (and often the only product) already being offered. Further, more prominence needs to be given to the owner’s personal needs both for relationship building and relationship “stickiness.”

 

Concluding thought. Banks focusing on small business lending risk missing a relationship building opportunity. First, lending in an economic environment in which quality borrowers are concerned about building debt makes little sense. Of course, lending is appropriate, but do so for a better reason than to get assets out the door. Lend to small businesses in the context of a larger profit and growth opportunity.