Tom Wagenhauser, president of IT-service firm Techlocity Inc., said he didn’t even consider a bank when he needed money to help finance an acquisition in 2013.
He said he knew the process was going to be arduous and time-consuming, so he borrowed $50,000 from an online non-bank lender, even though the interest rate on the six-month loan was north of 20 percent.
“I just knew that I would put all that work in, and get to the end [and] maybe not even qualify,” he said about his firm, which was founded in 2009 and employs 35.
Wagenhauser is probably not alone in his sentiment about borrowing from banks, a sentiment that might help explain why small-business loans across the country have struggled to rebound to pre-recession levels while commercial loans overall have. The trend has caught the attention of researchers and advocacy groups, which are wondering whether banks are losing interest in low-dollar loans vital to small operations or small companies are losing interest in banks.
According to the Federal Deposit Insurance Corp., at the end of 2008 Indiana financial institutions had $4.6 billion in small-business loans on the books that originated for less than $1 million. That figure stood at $3.8 billion this past June, about 17 percent lower.
Meanwhile, commercial loans are up 3.4 percent this year, to $9.5 billion. Because small-business loans have struggled to keep pace, their share of all loans has fallen from about 50 percent in 2008 to 40 percent this year.
The trend is similar at the national level, statistics show, and some observers think it has nothing to do with a lack of demand for five-figure and low-six-figure loans.
“It’s pretty clear that, in the small-dollar area, there is unmet demand,” said senior Harvard Business School fellow Karen Mills, who’s also the former chief of the U.S. Small Business Administration. “And the traditional institutions have a sweet spot that is slightly higher—call it $500,000 to $5 million.”
Mills co-authored a July 2014 paper on the state of small-business lending, and she said researchers were curious why banks were saying they were extending all they could to creditworthy borrowers when small businesses were saying they had a tough time getting bank loans.
She discovered the disconnect was with loans under a half-million dollars, the range where most small businesses seek to borrow. The costs to underwrite a $100,000 loan are about the same as for a $1 million loan, Mills said, so banks have tended toward loans that deliver more hearty returns.
She said the economics of running a bank in an era of heightened regulations have “pushed them in that direction.” That, coupled with the disappearance of some community banks that serve the small-business niche, “really mean that it’s not likely to turn around.”
Barbara Quandt Underwood, director of the Indiana branch of the National Federation of Independent Business, said the trend has more to do with borrowers’ uncertainty. From firsthand stories and organizational surveys, her sense is that small businesses aren’t confident enough to borrow money.
“They’re hunkering down until they have the confidence that the economy isn’t going to bite them,” Underwood said.
Conan Knoll, director of entrepreneurship with California-based Small Business Majority, disagrees. He noted that, in a 2012 nationwide poll conducted by Lake Research Partners, 90 percent of 500 small-business owners said access to capital was a problem.
“To me, that indicates that they’re trying to get loans; they’re just not having success,” Knoll said.
Bankers have a variety of opinions on the trend. Tim Massey, regional president for BMO Harris Bank, said larger firms just have been borrowing at a faster clip in recent years and using the cash to fund stock repurchases and M&A activity. Small-business loan activity isn’t surprising, he said, given that U.S. GDP is hovering around 2 percent a year.
Ben Pidgeon, vice president of private banking at MainSource Bank, said some of the larger regional banks have swum upstream to larger loans, a trend he believes is partly driven more by a lack of small-loan demand from quality borrowers.
For “250,000 or under, anybody that wants to borrow money, I will have that conversation and would love to try and find a way to say yes,” he said. “Demand is just soft.”
Mills, the Harvard fellow, said her research suggests small businesses are looking for capital, and one indicator has been the burgeoning balance sheets of online alternative lenders.
These firms include San Francisco-based Lending Club Corp. and New York-based On Deck Capital Inc. While they hold only a sliver of the $700 billion small-business loan market, they’ve been doubling their portfolios year over year.
These technology-driven companies look at real-time cash flow and other metrics beyond credit scores, and can make a decision in days, not weeks. Mills said it’s good that entrepreneurs are stepping up to fill the need, but the costs are higher and the industry is largely unregulated.
“You don’t want to kill nascent businesses filling the gap,” Mills said, “but on the other hand, you don’t want this to turn into the next sub-prime crisis and you don’t want small businesses to be taken advantage of.”
Beverly Johnson, founder of At Home Health Services LLC, has tapped various funding sources since starting her business in 2010—from family savings to a $5,000 microloan to a $350,000 SBA-backed loan from a regional bank.
Earlier this year, she borrowed $200,000 from an online alternative lender at a double-digit interest rate she was embarrassed to share. It withdrew loan payments daily from her bank account, she said, which strangled the firm’s cash flow, and she had to refinance with another lender for breathing room.
She said she’ll never go that route again, but she’s also not going to limit herself to banks, because the process is so arduous.
“I don’t have a negative feeling about banks, but they’re very stringent. And for small businesses trying to grow, there are so many obstacles,” Johnson said. “My first choice would be to research alternatives that would be tolerable to the small-business owner and more compassionate to the challenges that we face.”•