The economy has improved over the past 18 months to the point where small businesses are again looking to borrow money for their expansion plans. Big banks have returned to this space in a big way and are now granting one-in-five loan requests. While this is still a bit low, the 20 percent approval rate is still higher than at any point in the past five years. Further, smaller banks, which are approving more than 50% of the funding requests they receive, have become aggressive in the SBA lending space.
Last week, a Wall Street Journal front page story arose from data that Biz2Credit provided reporters about the number of bank failures in the Southeast--Georgia and Florida, namely. In these states and other areas, including California and Illinois, the funding gap frequently was filled by alternative (non-bank) lenders. I coined the term "credit desert" for areas where small business lending essentially dried up.
The states hit hardest by the collapse of the housing market were the areas with the most failed banks. Other states also had failures, but and the banks that survived were very conservative in lending to small businesses. Even companies with strong credit scores were rejected. Thus, one result of the housing bust was that small business owners often had to borrow high cost money to sustain growth. Many times, entrepreneurs paid 40 and even 50 percent interest on an annual basis, because loans at 20 percent were done at six-month terms.
Fortunately, technology proved to be a market changer in small business lending--especially when banks shut off the spigot from 2008-2011. Because of their early adoption of technology, user-friendly sites and mobile capabilities, alternative lenders were--and still are--able to make quick funding decisions. Banks, on the other hand, particularly when making SBA loans, take a long time to finalize the deal. Meanwhile, alternative lenders could sometimes grant funding in 24 hours, but there was a price to pay for this convenience in the astronomical interest rates they charged. This high cost of capital is unsustainable for most small businesses, particularly ones that might not have the highest credit scores.
In order to improve access to capital, I believe the following three things must occur:
1. The SBA must better adopt technology.
Banks are better able to process funding requests electronically for non-SBA loans. However, much of the funding for smaller amounts requested by startups and growing businesses, are done via SBA loans. Yet, the agency does not allow for digital applications and eSignatures. Because the agency does not accept electronic transfers of information, such as borrower tax filings from the IRS, it still requires submission of mountains of paperwork. This takes valuable time that small business owners could be spending doing something more productive. To her credit, SBA Administrator Maria Contreras-Sweet has said she is working to better streamline the process. Now, the changes must be made.
2. Small businesses must balance speed (alternative lenders) versus lower cost of capital (SBA loans).
If borrowers can wait for a few weeks, SBA loans usually offer the lowest interest rates. Right now, big banks that are doing non-SBA loans are transacting a lot of deals. However, the larger institutions tend to focus on bigger deals and many of their "small business" borrowers are not really that small.
3. Institutional lenders will emergence as major players in small business lending.
Insurance companies, family funds, and others are able to offer small business owners amounts averaging $1 million and are doing so at more competitive interest rates than other non-bank lenders (cash advance companies, etc.) Their entrance into the small business lending space is driving down the rates that other so-called alternative lenders are able to charge.
We may never see the loose, free flowing stream of capital that we experienced in the late 1990s and early 2000s. That might not be a bad thing, as lenders have become more diligent in doing their research on prospective borrowers, in large part due to the availability of financial data. Lenders, by necessity, streamlined their processes and many institutions are making loans at historically low interest rates.