Why Small Businesses are in a Cash Crunch

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Big Banks and Credit Unions Lend Less based on Stricter Criteria; Small Banks and Alternative Lenders Pick up Slack.

Recent Reports Find Mixed Results for Small Companies Pursuing Capital

Small businesses depend on loans and merchant cash advances to manage monthly cash flow, but with the tighter lending regulations in place since 2007, it has become increasingly difficult for businesses, in particular small businesses, to get loans from banks and credit unions.  Several reports are indicating that larger banks and financial institutions, having received significant government capital infusions, are not lending this money out to the small business community.  In turn, this has created a lender’s market for alternative financing companies.

Trepp, LLC released its first report on Wednesday, October 10thThe Capital Adequacy Stress Test Report, which uses its own model to evaluate balance sheets and income statements for more than 6,000 US banks, found that 1 in 8 banks received a “failing” grade.  The Trepp Report uses elements of the Fed’s “Comprehensive Capital Analysis Review of the largest banking institutions earlier this year.  In addition Trepp’s Capital Adequacy Stress test combines hypothetical scenarios for asset performance, capital and earnings over a 9-quarter projection against individual bank data. 

With banks on the brink of capital inadequacy, it’s no surprise that small businesses are historically low approval rates.  Trepp reported that nearly 40% of losses were attributed to bad commercial real estate loans.  With real estate markets still unsettled and record unemployment rates (an indicator of an unstable business market place) banks are holding onto capital to fortify reserves with the hopes that the market will somehow correct itself without additional capital infusion.

In addition, Trepp reported that, of banks that failed the test, the highest percentage of failure was among mid-sized banks, defined as having less than $10 billion in assets.  Mid-sized banks have historically been one of the largest lenders to the small business community on an asset to asset basis.

In their most recent August report, the Biz2Credit Small Business Lending Index, a monthly analysis of 1,000 loan applications on Biz2credit.com, revealed some surprising statistics.  While loan applications in August increased by 4.3%, their approval rates increased at small banks and alternative lenders, while big banks and credit union approvals dropped.

Funding requests by big banks dropped 4.5% from July to August (a 10.9% approval rate from 11.3%), a negative trend considering that big banks had experienced an uptick in approvals the prior two months.  Small bank lending (banks with less than $10B in assets), however, increased slightly (up 1.8%) from 47.4% in July to 47.8% the following month.  August represented the highest rating percentage for small banks since Biz2Credit began its index in 2011.

These shifts, as explained by Bi2Credit CEO Rohit Arora, are due to greater regulations and underwriting standards which require banks to meet tighter underlying capital ratios.  The markets have seen a rollout of a series of regulations since the initial tightening of global credit markets and bank failures of 2007 and 2008.

Credit unions, like big banks, also saw a decline of their loan approval rates in August.  After three consecutive monthly declines, Biz2Credit reported August approvals at 52.9%, in part caused by a lending cap reported by many credit unions which prohibited them from lending more than 12.25% of their total assets.

The tightening of traditional credit markets has opened up an opportunity for alternative lenders -- accounts receivables, merchant cash advance, local government lending institutions, micro lenders, and others.  Alternative lenders approved 64.5% of applications, up 6.5% from August, the highest approval rate on record since the Biz2Credit Index began. 

Similar reports by other marketing and research firms are showing identical trends.  According to a recent report by the Small Business Administration that measures bank lending from June year-to-year, bank lending in 2011 dropped 6.9% over the previous twelve months from $606.9 billion to $652.2 billion.  The trend has also been consistent since 2008 when banks had lent more than $700 billion in outstanding loans to small businesses. 

While loans to small businesses are on the decline, loans made to large businesses are on the increase, rising 5.8% over the same period of time.

The SBA report is based on data from provided by banks and from Community Reinvestment Act Reports. However, assumptions are made as loans made to businesses for under $1 million are assumed to be lent to small businesses.