Banks have cash and rates are low. But for many small companies, getting credit will be tougher than ever.

For entrepreneurs, financing options started drying up a good year and a half ago with the bursting of the dot-com bubble, leaving most companies reliant on an increasingly cautious banking community. Now the stock market is in decline and a national recession seems inevitable. The question for the year ahead regarding bank loans is, What should company owners expect about both the availability of money and the cost of borrowing? Inc's finance editor, Jill Andresky Fraser, interviewed banking experts to get some answers.

Barbara Grogan is president and CEO of Western Industrial Contractors, a construction company in Denver that's projecting sales of $20 million to $25 million in 2001. Grogan was the chairman of the Federal Reserve Bank of Kansas City's Denver branch from 1989 to 1994.

"The Fed has made it very clear that it will support the liquidity of our banks. It's done everything it can do to keep the supply of money vigorous and to reassure the financial markets. But what the Fed cannot do is mitigate the business risks that banks face in this type of economic environment. And that's a very big problem.

"The economy was in a pretty serious state of struggle even before the heinous acts of September 11. The amount of debt that existed in this country, on both the business and consumer ends, was risky. When you think about what we can expect next -- not just in the airline industry, the financial-services industry, tourism, and entertainment, but in all the businesses that support them, the domino effect from all the jobs that are being lost -- I think we're facing a long and arduous process. It could take a year or two or even three before we recover.

LIMITS TO THE FED: "What the Fed cannot do is mitigate the business risks that banks face," says Barbara Grogan, former chairman of a federal reserve bank branch.

"What does this mean for bankers? They've got customers whose ability to repay their current debt has been significantly impaired. So a bank is really no better off than the rest of the economy is. Banks are going to have plenty of customers declaring bankruptcy, defaulting on loans. The Fed can't do anything to prevent that. So we're going into 2002 with plenty of liquidity and a low cost of borrowing, but that's not going to be enough to keep banking options strong for most small-business owners. Will the Small Business Administration's loan programs compensate for all the difficulties that surround us? The answer is a big fat no. They're just too slow moving to help all those companies that are virtually DOA.

"But even with a difficult banking environment for the foreseeable future, there's one good thing: small business may get hit hardest, but we also rebound fastest because we're lean and mean and fleet of foot. So we'll be back fastest. It's just hard to say when."

Jim Houston is a senior vice-president at MB Financial Bank in Chicago, which specializes in serving young companies that have $3 million to $30 million in sales.

"I think that the Fed has done everything it can to make certain that healthy companies are able to borrow the funds that they need. But the issue is credit underwriting. Banks have been tightening their standards since the first quarter of 2001. They had to do that in response to an economy that was teetering between a recovery and an extreme slowdown. Those tighter standards are certainly going to remain in place for the foreseeable future.

"That makes it harder for many companies to borrow money. But it kills me when people say that banks only want to give you money when you don't need it. We're not a nationalized industry -- we're a profit-making business just like any other company. We give money to people who can turn it around and use it properly. We can't just give our money away to anybody who wants it.

"We also can't make loans at rates that are so low that we're losing money. That's something a lot of people don't understand. No matter how much the Fed lowers rates -- and I don't see how it can go much lower -- we can only lower our own rates so far, because we've got fixed costs, like any business. At our bank we just can't do a lot of industrial commercial mortgages, for example, at rates below 7%. We can't bring that rate down to 5%, no matter what the Fed does. We cannot make money at that level.

"What can small-business owners expect? I think that many companies will learn, during the next year or so, just how good their banking relationship really is. I don't think that big banks will be able to be very flexible in their dealings with smaller companies. But I do believe that smaller banks like ours will try hard to work with those existing customers that experience difficulties. We've already had some cases of covenant violations, companies that are clearly in trouble, and we've been trying to work with them. I think we'll see more of that moving forward."

Doug Smith is a partner in the San Francisco offices of law firm Gibson, Dunn & Crutcher LLP. He represents small companies and major banking institutions.

"During the past year we saw a fundamental shift in the financial markets to favor those companies that had a business plan for profitability as opposed to growth. I think we'll see more of the same moving forward. From the perspective of both the private-equity markets and the banking community, we'll see a focus on supporting companies with profitable business plans -- and in the case of banks, they'll also look for companies that are building their asset bases.

"The core question in all this is, Will banks be the saviors of the entrepreneurial community? I guess my reaction is, to the extent that someone has assets and a clear way to repay the loan, banks will bend over backwards, in part because of pressures from regulators and the public. But given the difficulties in the economy, that's not going to happen for a company that doesn't fit those lending standards. Banks won't become charities."

Jill Andresky Fraser is Inc's finance editor.

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