Small business still reeling from credit crunch
Vicky Vij is no stranger to adversity. Over the past 12 years, the immigrant from Delhi worked tirelessly to build Bukhara Grill in midtown Manhattan into a thriving restaurant with sales of over $2.5 million a year.
Even the Great Recession didn't crimp business: The company boasts 12 straight quarters of profitability. So when an opportunity arose this year to expand by buying a catering business, Vij decided to take the leap.
But like so many entrepreneurs, Vij was snubbed by commercial bankers who were unwilling to make small business loans—even to a company with a gold-plated credit score of 725.
"The process was gut wrenching," he said. "The amount of paperwork they wanted me to cog through was impossible."
Like many tenacious small business people squeezed by the credit crunch, Vij scoured the market for help in fundraising and stumbled on Biz2Credit.com, which matches loan applications to a network of 1,200 lenders throughout the United States.
"The company helped me find a small community bank willing to take on the risk with credit guarantees from the Small Business Administration," Vij said.
The $3.9 million, 25-year loan from Celtic Bank in Salt Lake City was 75 percent guaranteed by Uncle Sam and came with favorable terms. It has an interest rate of 6 percent collateralized by the assets of the business Vij was acquiring: a 25,000-square-foot banquet hall and equipment.
Vij's tale exemplifies the credit squeeze still affecting America's small businesses. While banks are reporting improved earnings and a double-digit uptick in business lending, the little guy is still not feeling the love. Statistics tell the story. For the first time since the start of the financial crisis, banks are lending more than they did in 2008. Higher profits and healthier balance sheets have helped open the money spigot.
In its second-quarter report, the Federal Deposit Insurance Corp. said that earnings on the commercial banks and savings institutions it insured rose nearly 23 percent from a year earlier, to $42.2 billion. It also noted that asset quality is improving. The average return on assets, a yardstick of profitability, rose to 1.17 percent from .99 percent a year ago. The figure represents the industry's highest quarterly ROA since the 1.22 percent in second-quarter 2007.
The Funding Gap
The data on small business lending paint a bleaker picture. FDIC data show a 19.1 percent decrease in small business loans ($1 million or less) outstanding since the start of the Great Recession. In 2007, $686.8 billion in loans were issued, compared with $587.8 billion last year (see chart). In contrast, loans to midsize and large companies rose from $1.5 trillion in 2007 to $1.9 trillion in 2012—a 12 percent increase.
Even the $30 billion Small Business Lending Fund launched in 2010 as part of the Small Business Jobs Act was a nonstarter. It dispersed only $4 billion because many community banks found the program's requirements too stringent, and the Treasury Department was slow to approve applications. The department reported that just 933 of the nation's 7,700 or so community banks participated in the program, and many of those that did participate used funds to pay back the Troubled Asset Relief Program.
"What we are witnessing is the classic dilemma," according to Andrew Sherman, a partner at Jones Day in Washington who advises small and midsize companies on corporate finance. "When the banking industry gets soft and becomes risk adverse, small business lending is the first to go and the last to recover."
Another problem is that it is more difficult for bankers to value business credit risk, Sherman said. As company balance sheets move away from tangible assets such as inventory, equipment and real estate toward intangibles such as brands, technology and relationships, commercial bankers are having trouble figuring out how to secure their loans. This shift has forced emerging growth companies of every ilk to look for fundraising help and alternative financing options.
For a pulse reading of recent activity, look at the Small Business Lending Index, published by Biz2Credit.com, a tool being used by the Obama administration's Council of Economic Advisers. Banks with assets of $10 billion or more approved 17 percent of small business loan applications in July.
While that figure is better than last year, pre-recession approval rates hovered around 36 percent, according to Rohit Ahora, founder and CEO of Biz2Credit, an exchange that has arranged more than $1 billion in funding for small business owners over the last five years.
Stricter requirements have made the bank loan process onerous for the vast majority of entrepreneurs, according to Ahora. "Banks are looking for at least three consecutive years of profitability and are demanding more personal collateral," he said.
More lending is secured by collateral now than before the recession. The Federal Reserve's 2013 Survey of Small Business Finances shows that 76 percent of the value of loans between $100,000 and $1 million was secured by collateral in 2007, versus 80 percent this year. The decline in real estate values since the end of the housing boom has made it difficult for businesses to meet these requirements.
"Many small business owners cannot cope with the stress and just skirt banks entirely," said Paul Quintero, CEO of Accion East, a microlender that provides loans of $500 to $50,000 to 1,500 small business owners throughout the country.
As a result, microlenders and other alternative debt providers such as credit unions are seeing a surge in activity. Accion's loan volume has risen 40 percent in the past seven months and is up 80 percent in some markets, including the New York area.
The attraction for entrepreneurs is often the faster turnaround in fundraising. That is key for high- volume, cash-intensive businesses like Carpella Trading, a $5 million telecom company in Jackson Heights, N.Y., that buys minutes from carriers wholesale and then sells phone cards retail. The company needs a secure line of credit and a steady stream of cash to sustain its 20 percent profit margins.
After being rejected by 10 commercial banks, Carpella's owner, Summit Kumar, secured a $50,000 line of credit with an 8 percent annual interest rate from Accion in 30 days.
"Cash is the lifeblood of my business," he said. "Securing the capital was key to my company's survival."
James Chessen, the chief economist at the American Bankers Association, said, "This recovery cycle has been particularly tough for small businesses on the prowl for debt finance."
The problem has been exacerbated by a sharp decline in the availability of equity capital. Through the first half of this year, $12.6 billion of venture capital was invested, versus $15.2 billion during the same period in 2007, according to data from the recent Pricewaterhouse Coopers/National Venture Capital Association Moneytree Report. About $27 billion was invested in all of last year, a $5 billion shortfall from the pre-recession level.
The small business credit crunch has had far-reaching economic impact. National Association of Independent Business data indicate that only 9 percent of small businesses plan to expand, and only 23 percent intend to make capital investments this year, according to survey results from its Small Business Optimism Index in July. The survey reinforces anecdotal evidence that owners are reluctant to take on debt to grow because of regulatory requirements, high taxes—and the trouble in fundraising.
So what's next?
"I think we will see a gradual thaw in the small business lending market," said Richard Brown, chief economist at the FDIC.
Considering that small businesses represent 99.7 percent of all businesses and create more than half of nonfarm gross domestic product, the Obama administration is expected to continue looking for ways to loosen bankers' purse strings.
In the meantime, innovators like Ahora and Quintero will try to fill an unexploited niche in the marketplace. It's economic Darwinism at its best.
—By CNBC's Lori Ioannou