The Credit Squeeze

Sure, loan rates are a bargain, but what if you can't get one at any price?

Six months ago, Brian Schindler embarked on a money hunt to finance a move to bigger quarters. He figured he would have no trouble getting a $250,000 loan. After all, Pace Elevator--his 20-employee New York company that installs, modernizes, repairs, and maintains elevators--had been around for 17 years. Its revenues were $2 million last year, up from $500,000 when he bought it in 1997. "It's a viable and growing company," says Schindler.

Schindler never expected to have the doors closed in his face by the same two banks that had extended him $100,000 credit lines in 1999. Their reason: The slowing economy. "All of a sudden, policies have become a lot more stringent," laments Schindler.

SAY GOODBYE TO EASY MONEY. Welcome to a world of tighter, if more realistic, credit. During the economic boom of the '90s, lenders aggressively courted small companies. "Before last summer, banks were all go-go and less discriminating on underwriting criteria," says Stephen E. Roulac, a San Rafael (Calif.) financial consultant. Nonbank lending mushroomed, and venture capital flowed abundantly into small startups. At first glance, it even appears the Federal Reserve has made conditions easier by cutting the federal funds rate four times this year. Banks in turn have reduced their small-biz lending rates. The average rate for loans under $100,000 fell to 9.45% in the first quarter, from a peak of 10.36% last summer.

But lower rates don't help if you can't get a loan--and there's mounting evidence that small-business lenders are getting a whole lot pickier. A sampling:

-- Standards are getting stricter. The Federal Reserve's March, 2001, survey of senior loan officers showed that 43% of domestic banks had imposed tighter lending standards for small businesses since January, vs. 10% in the January, 2000, survey, and just 4% in January, 1999. Also in March, 48% of banks reported charging higher spreads on high-risk loans, vs. 22% in January, 2000.

-- Lenders are demanding more collateral. Phoenix Management Services, a Chadds Ford (Pa.) turnaround management company that does a quarterly survey of credit conditions, says that, on loans of $1 million to $5 million, 42% of lenders planned to increase their structural requirements, which include collateral, up from 18% last year. For loans under $1 million, 36% planned to tighten up, vs. 24% last year. Consider Pixius Communications, a wireless broadband company in Wichita, which sought a $500,000 loan last summer. The same bank that had lent it $750,000 in 1999 was suddenly demanding personal guarantees, personal property, and company assets as collateral. "This kind of treatment is simply intolerable," says Gary Carty, chief operating officer of Pixius, who had a 15-year relationship with the bank.

-- Approval rates are dropping. Lending officials, including Richard Tambor, senior vice-president for lending at American Express Small Business Services, say that more loans are being denied industrywide. Indeed, the Phoenix report found that 70% of lenders surveyed in the first quarter expected their small-business lending to drop over the next six months, vs. 39% last year.

-- Credit-card use is rising. In yet another indicator that entrepreneurs are feeling the credit pinch, NFO WorldGroup in Greenwich, Conn., says 10% of small-business owners expect to use personal credit cards for business expenses this year, compared with 4% in 2000.

HOW WORRIED SHOULD YOU be about these trends? That depends on your business. So far, members of the National Federation of Independent Business, which tend to be more established businesses, aren't troubled by tighter credit, judging by NFIB's March survey. Just 3% ranked it a top concern."Banks may have raised the bar. But we're still able to get over it," says William C. Dunkelberg, NFIB's chief economist. Companies with strong financials and long track records will fare best during this credit squeeze, but they'll still need to make a strong case for how they plan to use the loan.

You're more likely to get your banker's cold shoulder if you're a startup, if your cash flow is spotty, or if you're in a slow-growth or troubled industry. Quirky business propositions that might have intrigued a lender in flusher times aren't as likely to get funded now either. For instance, Mark Mercadante, president of Dante Builders, a land development company in Oxford, Mass., has been trying for more than a year to raise $2 million to develop an upscale, designer cemetery with lush gardens and stylish atriums. He and his partner in the project, neighbor and longtime friend Timothy Joyce, called on two banks and a mortgage company last year to no avail. So Mercadante focused instead on finding some willing investors. "Most banks don't have the experience of dealing with projects like this," he says.

It's not just banks that are pulling in the welcome mat. Two nonbank players disappeared from the small-biz lending scene entirely: Boston's PrimeStreet Corp., an online broker, went bust in March, and in February, Heller Financial Inc. (HF ) in Chicago, until recently one of the biggest small-business lenders in the nation, dropped out, saying it couldn't meet growth and profit goals.

For many entrepreneurs, it makes sense to combine debt and equity financing. But venture capitalists and angel investors are growing cautious, too. Just ask Lisa Hammond, president of Femail Creations, a $6 million company in Las Vegas. In 1999, she got a $750,000 Small Business Administration loan that helped her expand her mail-order sales of women's clothing, jewelry, and home accessories. Last year, she was ready to double her catalog's circulation but needed a further $3 million to $5 million. Hammond had as much debt as she could handle, so she was hopeful when investors approached her. But they all backed out after Nasdaq's April, 2000, collapse. "We were disappointed because this year was going to be our big push," she says. Instead, she's put the expansion on hold.

When major banks and investors turn you down, you could try your local community bank. That's how Pixius' Carty finally managed to borrow $250,000. But borrowers should expect to pay higher rates--about half a point more than at a big domestic bank, according to Fed data.

Some entrepreneurs can find loans through specialized bank lending programs with more flexible terms. Last year, Sandra Marks and her husband, George Joseph, went to their bank for a $100,000 loan to expand their $500,000-a-year Long Island City (N.Y.) knitwear import business, N8tive Nits Inc. "They told me I didn't have the cash flow to qualify," Marks says. "What can you say to that--when that's the reason we were trying to get a loan in the first place?" Finally, she landed an SBA-backed $100,000 loan last September through FleetBoston Financial Corp.'s Women Entrepreneur's Connection (FBF ), part of its specialized-lending unit. Warren Krug, vice-president and SBA sales executive at Fleet, was impressed by Marks' client roster. "She brought in catalogs of blue-chip companies who were selling her products, and I had the confidence she could grow and expand her company."

If you can hold off a bit longer, the credit picture could improve by yearend. Competition for small business borrowing remains fierce because it's quite lucrative, and some major lenders are gearing up for better times. Chase Manhattan Bank expects its small-biz lending to rise 30% to 35% this year, and Business Loan Express, a unit of Allied Capital Corp. (ALLC ) that makes SBA-guaranteed loans, is hoping for a 20% gain.

But how do you cope without cash in the meantime? Try cutting costs or putting the pet project on the back burner. Or boost your cash flow some other way. The stopgap solution for elevator-company owner Brian Schindler has been to coax customers into paying within 30 days instead of 60 and persuade his own vendors to extend his payment schedules. For now, that's all the lift he's going to get.

By Naween A. Mangi

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