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Small biz loans: Is it really Wells Fargo or nothing?

Street begger
In the SBA’s new 0-2(b) loan program, eligible small business owners are given a Big Gulp cup, a sheet of cardboard, and a magic marker.

Now that CIT has filed for bankruptcy, who’s filling the void that they leave in small business and supply chain financing, since they were the top dogs in both until very recently?

Up until just a few short months ago, CIT originated by far the lion’s share of small business loans and lines of credit in this country. Over-exposed in the derivatives market, CIT converted from an industrial loan company to a chartered state bank last November in order to score $2.33 billion in TARP funds last December 23. But the depth of the recession took a severe bite out of their balance sheet because of snowballing small business loan defaults, and in July, the Obama administration refused to throw good money after bad when CIT needed $2 billion more in taxpayer money.

Beginning in December, CIT slashed its small business loan portfolio and really took out the axe in July. More importantly, however, CIT was the leading “factor” in purchasing discounted receivables from small- and medium-sized firms needing an infusion of cash to meet immediate needs or inventory production orders. While factoring (when a financial institution, such as a bank, “buys” accounts receivables from a business for an immediate upfront payment — 70 to 90 percent — and a later, “reserve” payment minus fees when the debtor pays up) has become the grease for multinational corporate growth — for instance, factoring is what has largely driven China’s economic growth — it has always been and will always remain one of the key financial tools available to entrepreneurs and small business owners, particularly highly innovative, high-growth small businesses.

So who’s going to throw this party now that CIT has pretty much gotten out of the business of small business loans? Aside from Wells Fargo, it pretty much looks like every other bank is packing up their toys and playing elsewhere, most tellingly displayed in the 36% drop in SBA loans this year from last.

Here’s a chart showing the decline in small business loans by America’s top six small business lenders — all lenders whose small business loan volume topped $300 million in 2008 — between the end of fiscal year 2008 and fiscal year 2009 (for the SBA, the fiscal year ends on October 1):

Small business lending volume FY 2008-2009

All told, only Wells Fargo will end the year lending more than $300 million. But the increase in small business lending by Wells Fargo (about $23 million) is more than offset by the steep declines by the other major six lenders, giving 2009 a total loss of 1.5 billion in small business lending by the big six (and if you count the top ten small business lenders — including T D Banknorth, Comerica, UPS, and Temecula — the latter has suspended all small business lending — then you have a total loss of small business lending at somewhere around $2.06 billion.

Equally worrisome for small businesses and retail suppliers are the declines in factoring, not normally a financial practice subject to big risk. However, the creditworthiness of receivables debtors has declined just as precipitiously as the creditworthiness of businesses everywhere, so the risk to the factoring bank or institution is much higher, so they’re demanding higher fees to purchase those receivables or refusing them altogether. And, if you’re into recondite financial analysis, Ben Sopranzetti found that the increased bankruptcy risk of the sellers puts factoring out of reach for them (whereas — you would think — only the creditworthiness of the debtors should come into play, no?) And if there’s one reality all us entrepreneurs and small business owners have had to stare directly in the face, it’s the imminent possibility of bankruptcy.

(We are not, of course, counting consumer credit cards which are the dominant form of factoring finance in the world.)

Factoring at CIT, our bankruptcy of the month, has declined almost 25% from fiscal year 2008. While it’s not the freefall in small business lending, it represents a huge crimp in the ability of suppliers and retailers to do business. (And, of course, it represents a significant loss for CIT since factoring is its “bread and butter” to quote one analyst).

Total factoring volume worldwide grew at 15% in 2007 but only 2% in 2008; this year, we’re headed for a significant decline, probably as much as 12% — the first time this has happened since 1985.

So while the mainstream press concentrates on small business loan volume, the steady decline in factoring — now made pretty serious with the CIT bankruptcy — is disrupting the cash flows of innumerable small businesses.

Which leaves us Wells Fargo — and my numerous dealings with them have put them more squarely in the stagecoach robbers category than the stagecoach drivers.

While Wells Fargo clearly sees small business lending as a sterling opportunity in this downturn, how much can we expect Wells Fargo to make up for the losses in small business lending from more short-sighted institutions?

A large factor in Wells Fargo maintaining their current small business loan volume has been their rigorous strategy in performing adequate due diligence because the bank tends to hold on to their small business loans rather than sell them as quickly as possible on the secondary market. Folks like U.S. Bank, Chase, Popular, and the rest of the big ten instead focused on reselling the loans before the ink dried on the signature lines. With the downturn, of course, the secondary market in small business loans has dried up like a prune sunbathing in Death Valley.

More importantly, Wells Fargo limits small business loans almost exclusively to SBA 7(a) loans, which are partially insured by the SBA, and kept their mitts off of SBA Express loans, which are the ones everyone’s been defaulting on in the last year.

The upshot for small business owners is obvious. While Wells Fargo isn’t abandoning the market, they, like their competitors, are only doing business with the most creditworthy small businesses. In other words, you have as much chance getting a small business loan from Wells Fargo as you do from, say, Chase, even though Chase’s small business loan volume has dropped by over $200 million. Why? Because Chase has adopted, more or less, Wells Fargo lending standards — meaning all those non-7(a) loans are going begging.

The good news is that the SBA, in part mandated by the Recovery Act of 2009, has expanded eligibility for 7(a) loans and increased the guaranteed portion of the loan to 90% (meaning that the lender is only taking on the risk of 10% of the loan). The eligibility changes, which essentially expand eligibility for a 7(a) loan to any small business that qualifies for the agency’s 504 Certified Development Company loan (company net worth cannot exceed $8.5 million and income after federal taxes cannot exceed $3 million), thus adding some 70,000 small businesses to the 7(a) roster, including car dealerships, auto industry suppliers, and not a few consumer goods manufacturers.

Because of the government guarantee, however, banks are expected to do much more thorough due diligence than they usually do on loans they resell quickly. That, in part, explains why 7(a) loan volume has decreased in many areas — as high as 50% — the recession has made many a small business a much greater lending risk. Sure, the loans are guaranteed, but Uncle Sam is a much more demanding taskmaster than the supposedly self-correcting free market.

Still, despite the bad news, the program is going to run out of money ($375 million in TARP funds) in a few weeks — so something is going right.

The news for factoring isn’t much better. Last year, CIT was responsible for some $42 billion in factoring; Wells Fargo, at number two, is barely out of the gates at around $8 billion. And don’t expect them — or third-place GMAC or fourth-place Rosenthal & Rosenthal — to step into the breech. If CIT radically drops its factoring volume, expect that to reverberate all through the business world, including making life a bit harder for small businesses and startups.

The long and short of it is this: you have to be in good shape for a small business loan or at least not on death’s door if you want to raise cash by selling receivables. It’s not that small business lending is being shut down, it’s that lending to iffy businesses has been shut down. Wells Fargo isn’t the lone holdout in small business loans, it is simply the lender that has been following due diligence practices that the rest of the banking world have adopted in the last year.

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One Response to “Small biz loans: Is it really Wells Fargo or nothing?”

  1. Steve Monas says:

    With the bankruptcy, I am using ALL my Citibank airline miles now, as I am not sure what might happen after the reorganization.

    I have Citibank American Advantage airline miles. One Mastercard and one American Express, both from Citibank. They are integrated with my Quickbooks online. I pay off my credit cards at the end of each month, but charge everything to each to categorize my spending. Amex used for office supplies, Costco, postage, web hosting, etc. Mastercard is used where AMEX is not accepted, and to categorize my entertainment costs.

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