Jim Brown, owner of JWB Properties LLC, says community banks called him almost every day in 2006 trying to lend him money. Now, his homebuilding business in Atlanta can't get a loan.
"The small banks became really, really cautious, and real estate became a dirty word," said Brown, 65, whose one-man company takes on workers on a project-by-project basis.
Tighter lending standards among U.S. community banks help explain why small businesses are adding jobs at only half the pace of large employers. The Federal Deposit Insurance Corp. says the 6,900 institutions it classifies as community banks supply almost half of small business loans. Their health has become a focus for Federal Reserve Chairman Ben S. Bernanke and his colleagues.
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"If community banks are on shaky ground and unable to extend credit, the small businesses won't be able to expand their operations and payrolls," said Mark Zandi, chief economist at Moody's Analytics Inc. in West Chester, Pennsylvania.
Companies with fewer than 20 workers increased employment by 3.8 percent from February 2010 to April 2013, while the largest companies—with more than 1,000 on their payrolls—expanded their workforces by 8.6 percent, according to data compiled by Moody's and ADP Research Institute.
In the U.S., recent startup companies—which lead small businesses in creating jobs—have had a particularly tough time getting loans, according to an Atlanta Fed survey released in December of 495 small businesses in the southeastern U.S.
Among companies less than six years old, 41 percent couldn't get a loan at all, and 36 percent got less than the sum they requested. Among more mature employers, 23 percent were rejected, and 38 percent got just part of the amount they applied for.
Profitability Gap
That disparity reflects, in part, the gap in profitability between large and small banks.
In the fourth quarter of 2012, 21 percent of banks and savings institutions with less than $100 million in assets were losing money, according to FDIC data. Eleven percent of lenders with assets of $100 million to $1 billion were unprofitable, while among institutions with greater than $10 billion in assets, just 1.9 percent were losing money.
"Small banks are still trying to get up off the mat from the beating" from the past recession, said Russell Price, senior economist at Ameriprise Financial Inc. in Detroit. Some have been restricting lending to conserve capital, while others face tougher regulatory examinations and more rules that hurt lending, he said.
"With interest rates currently so low, it is an exceptionally difficult task for these banks to generate a profit and thus rebuild their equity," he said. That leads to caution in lending that is having "its greatest impact on the small businesses" that rely on community banks.
The availability of small loans, and community banks' ability to earn money amid increasing financial rules, have become concerns for Fed officials.
The Fed and the Conference of State Bank Supervisors last month announced plans for their first research conference on community banking in October in St. Louis. Four central-bank policy makers, led by Bernanke, will speak on what the chairman calls the "vital role" of small banks in the economy.
Fed Governor Elizabeth Duke, a former Virginia banker, said she often hears from small lenders who tell her they worry that community banking might not survive. Concerns include weak regional economies, near-zero interest rates squeezing lending margins, and an increased burden of regulations following the 2008 financial crisis, she said in a speech in February in Duluth, Georgia.
Regulators' Focus
Regulators have increased their focus on real estate-backed loans and commercial borrowers that started operations recently, said Jack Hartings, chief executive officer of The Peoples Bank Co. of Coldwater, Ohio.
"The regulatory scrutiny is a little more severe" for lending to startups and new companies, he said. "I may be questioned at the next examination" and a loan to such a borrower could be classified as a problem by regulators "even though I may not consider it" weak.
Julie Stackhouse, senior vice president for supervision at the St. Louis Fed, said regulators are "very concerned about the credit needs of small communities and the ability of the financial sector to meet them." If small banks can't provide local lending, "it is not clear other organizations" can fill that role, she said in an interview.
Since September 2007, 477 banks have failed in the U.S., led by 87 in Georgia and 68 in Florida, according to Trepp LLC, a real estate and financial data provider. That compares with just 20 failures in the U.S. during the six years prior to September 2007.
"In the wake of the bank failures, underwriting standards had tightened" in hardest-hit communities, even when failing banks were acquired by larger banks, the Government Accountability Office said in a January report to Congress. "New lending in certain kinds of loans was restricted in certain areas, such as collateral-dependent loans in areas where asset values declined severely."
While smaller banks are easing credit somewhat in response to an economy on the mend, "the improvements in the sector are certainly lagging the broader recovery," economist Price said.
That would leave them behind the largest banks, which relaxed lending standards during the previous quarter, according to a Fed survey of loan officers at 68 domestic banks and 21 U.S. branches and agencies of foreign banks conducted from April 2 to April 16.
The Fed doesn't gather similar data on lending standards at small banks. The Independent Community Bankers of America, a trade group, reported about 55 percent of community banks increased lending by an average of 3.6 percent in the fourth quarter from a year earlier. The group's report doesn't specify whether easier lending standards contributed to the increase.
Early Losses
The biggest banks generally recognized their losses tied to the housing bust and subprime crisis early on during the downturn, while the deterioration of construction or commercial real estate loans that hurt small banks took years to develop, the St. Louis Fed's Stackhouse said.
In addition, while the Fed ordered the largest U.S. banks to raise $74.6 billion in capital in 2009, many small banks don't have the ability to raise new capital and so therefore shrink their asset base by making fewer loans, she said.
Community bankers say lending is also held back by weak demand in markets where the economy is still struggling, as well as fewer qualified borrowers.
"Some of the borrowers have dents coming off the recession," with late payments or defaults, said Charles Crawford, president of the Atlanta-based Private Bank of Buckhead, which has been increasing lending. With a "tepid recovery" nationally, "a lot of good borrowers are paying loans back early," he said.
"A bank like ours wants to lend more," he said.
In Atlanta, homebuilder Brown, 65, said he has gotten private investors to help finance four homes with prices of more than $1 million each, though he says that isn't an option for most smaller builders. During the housing boom, he would get bank loans for good projects, Brown said. While he has talked with a dozen bankers over the past year, "they have no interest in dealing with a small builder."
JT Hroncich, 45, president of Capitol Media Solutions, an advertising-buying company started six years ago in Atlanta, said the lending environment is "still tough" for companies without long histories of profits. His firm got a line of credit for $75,000 from a community bank, compared to his request of $100,000.
That may reflect conservatism following the past recession, he said. "I wasn't disappointed," he said. "I totally understand. After 2008 and 2009, I completely get it."
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