Credit Markets 2000

Interest rates are up, but so is competition for small-business borrowers. If you want credit, it's yours.

Kathleen K. Diamond found plenty not to like as she sweated through negotiations for a $500,000 loan in August. Her company, Washington (D.C.)-based Language Learning Enterprises, a $2 million-a-year translation-services business, needed the money for new computer equipment. Her lender, Century National Bank, was willing to supply it. What bothered Diamond was the demand for a personal guarantee and the interest rate: 11.75%, significantly higher than the 10% the bank charged on the company's line of credit.

Still, Diamond eased her mind by recalling rates 21 years ago when she founded the company. "They were as high as 18%," says Diamond, 53. "So the 11.75% is not a deal-stopper." Translation: Things could be a lot worse.

Yes, interest rates have risen. Yes, some banks are tightening terms. But the fact is, it's still a good time for small businesses to borrow. Historically speaking, rates remain quite low. And credit is widely available, in part because competition for small-business customers is fierce among banks and nonbank lenders, each offering borrowers new programs and incentives. "This is a stable credit market," asserts John D. Donohoe, a risk-management executive for small business at Bank of America. Small-business owners seem to know it. In its July survey, the National Federation of Independent Business found only 5% of business owners identified the cost and availability of credit as their most important problem, compared with more than 40% in the early 1980s.


So why the anxiety? Mostly because things aren't quite so loose as they were. Besides the Federal Reserve's rate hikes of 1.75 percentage points since June 1999, some banks are looking a little more skeptically at the weakest borrowers. In its May senior loan officer survey, the Fed reported that in the previous three months, 36% of domestic banks had increased spreads on riskier loans to small businesses while 21% had tightened lending standards--the largest percentage rise of the past few years. That's a far cry from a year ago, when bankers were falling all over each other to lure small companies by offering low rates of 9.3%, slashing their own profit margins. The average rate today: 10.3%, according to the NFIB survey, a level not seen since September, 1997. What's more, consolidation in the banking industry is taking a toll. In April, a Small Business Administration study blamed mergers for a decline in small-business loans of less than $100,000.

Yet the biggest small-business lenders insist that despite the Fed's nagging they haven't tightened lending criteria or terms at all. "Our credit standards have been consistent for three years," says Marc L. Bernstein, manager of the Wells Fargo & Co. group that makes business loans under $100,000. He notes that despite higher rates, there's been no deterioration in credit quality. In fact, not only have delinquencies fallen nationally to 1.37% last December from 2.02% two years earlier, but in recent months, Wells Fargo borrowers have begun speeding up payments on variable rate loans.

That's led some lenders to pursue small-business borrowers even more aggressively with a variety of strategies (below). "We've loosened a little bit and are looking for opportunities," says Rick G. McNutt, senior vice-president for small-business financial services at Chase Manhattan Corp. For instance, the New York bank has intensified efforts to cross-sell credit products, and next year plans to grant clients more pre-approved loans. Women-owned companies are particularly prized by some major lenders. FleetBoston Financial Corp., among others, is going after the growing ranks of female entrepreneurs by earmarking set amounts of loans or investments. Owners like Christine K. Cortese, 30, and Tara J. Oolie, 30, appreciate the effort. In July, the bank made them a $450,000 SBA loan at 11% to start Just Calm Down, a spa and retail store in New York. Even though they had to use personal assets as collateral, their loan officer's help navigating the process made them inclined to use Fleet services again, they say.

In a drive to broaden its range of borrowers, Bank of America has expanded activity in leasing over recent months. Its lease deals are no cheaper than competitors', but the bank figures the convenience will be attractive to existing customers. Bank of America also has been using the two-year-old SBA Express program to bring in smaller borrowers. These unsecured loans of up to $150,000 carry a 50% guarantee versus the 75% guarantee on the standard, larger SBA 7(a) loan but require no SBA paperwork.

With so much attention lavished on small business by big banks, the impact of industry consolidation has been tempered. Indeed, when northeast regional bank Fleet Financial Group completed its acquisition of BancBoston last October to become FleetBoston Financial Corp., it promised to lend $7.5 billion to small businesses over five years. That's more than both banks had been offering as separate entities. So far, the bank is ahead of its target.


Where banks have tightened--or disappeared in mergers--look for hungry nonbank lenders to rush in. This year, Allied Capital Corp., in Washington, expects to lend up to $200 million to small companies vs. about $120 million in 1999. Heller Financial Corp., the largest SBA lender, projects $650 million in small-business loans this year, up from $536 million in 1999. As of 1997--the latest data available--nonbanks had captured 65% of the small-business financial services market, up from 49% 10 years earlier, says the Chicago-based Bank Administration Institute. They're giving traditional lenders--and their customers--something to think about. Bank of America did the initial 10-year financing on a plant for Larry D. Pentz, CEO of Pentz Design Patterns & Foundry, a maker of aluminum castings in Duvall, Wash. But Pentz wanted to shop around. So, when looking for $1 million for a building expansion and a $761,000 refinancing on his existing plant, he talked to GE Capital, which had handled an industrial revenue bond for him. "You always want a backup and besides, you get some competition going," says Pentz. Eventually, BofA got the business because of its rates and ease of service.

Perhaps the most formidable nonbank competitor nowadays is American Express Co., whose small-business services unit is trying to lure clients with new credit and charge cards. That makes sense: The annual Arthur Andersen/National Small Business United survey reported 50% of companies used cards for capital needs in 1999, while only 43% took commercial bank loans. (In 1997, just 34% borrowed on cards, while 38% turned to banks.) Issuers have pumped up the trend with small-business credit cards that offer rewards programs, varying lines of credit, and billing statements to make accounting easy. A card just introduced by Chase, for instance, offers lower rates than Chase's previous cards--3% in the first six months followed by prime plus three percentage points--as well as lower fees, merchant discounts, and a rewards program.

That's fine for the small stuff, but it won't help Arthur C. Fedrigan, CEO of Beckart Environmental. The Kenosha (Wis.)-based company, which makes equipment to clean industrial waste water, has just completed a $1.1 million plant upgrade and expansion. Most of the money came from a bank line of credit at 9.5%, up 1.75 points from early 1999. Fedrigan says the company can now grow from $8.5 million in 1999 revenues to about $10 million this year. But as rates head higher, he'll be more reluctant to borrow. The added debt plus higher rates have increased his monthly interest expense from $7,000 last year to $11,000. "It's going to crimp our expansion as time goes by."

Of course, a little crimping, along with expansion, is just what the Fed has in mind.

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