July 23, 2014
Karen Mills’ Harvard report on the state of small business lending paints a bleak picture, with the exception of technology.
Now that we’re about four years out from the depths of the Great Recession, it’s time to get some clarity on what exactly happened to the 28 million small businesses so vital to the economy.
We know these businesses were hit the hardest, but how hard may be a bit of mystery. We also want to know how they’re faring during the recovery, and what their prospects are for the future.
Look no further than former Small Business Administration chief Karen Mills’ erudite Harvard Business School paper on small business lending, entitled The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game, published Tuesday.
The paper paints a somewhat bleak picture of the lending environment critical to the growth of small businesses since the recession. At the same time, Mills, now a senior fellow at Harvard Business School, holds out a strong ray of hope for the role of new technology and alternative lenders in easing the small business lending gap.
Behind the Numbers
First things first–the recession was really bad for small business owners, as data from Mills’ paper shows:
- Between 2007 and 2012, the small business share of total net job losses was about 60 percent. From the employment peak before the recession until the last low point in March 2009, jobs at small firms fell about 11 percent.
- By contrast, payrolls at larger businesses shrank by about 7 percent. Jobs declined 14.1 percent in establishments with fewer than 50 employees, compared with 9.5 percent in businesses with 50 to 500 employees, while overall employment decreased 8.4 percent.
Mills has a unique perspective, having assumed her SBA post at the height of the financial meltdown. She watched as the SBA’s lending in its flagship guaranteed 504 and 7(a) loan programs fell off dramatically, cut in half as activity in the secondary market for the loans froze up.
Mills is credited with pulling a number of levers at the SBA to get banks lending again, through a combination of increased guarantees on loans and reduced fees for borrowers, as well as a personal lobbying effort to get community banks back into the fold. Her endeavors led to some record years of lending, with the SBA’s loan portfolio back up around $100 billion. Though some argue that the SBA’s increased lending size standards, which gave bigger businesses access to higher value SBA-backed loans starting in 2010, has played a role in extending the lending crisis for the smallest businesses.
Regardless, Mills is concerned that small businesses are still struggling and the credit gap is widening.
“If we fast-forward to the recovery, you have lots of banks who want to lend, but they have increased capital requirements, and they have some regulatory overhang,” Mills said in an interview with Inc. Monday, adding that banks are also looking for more clarity on what regulators want.
Specifically, Mills writes: Small business loans on the balance sheets of banks are down 21 percent since the recession, while loans to bigger businesses have increased about four percent over the same period. Part of the reason, Mills postulates, is that banks have simply lost interest in making smaller loans, because they are costly to underwrite and yield less than larger loans.
According to the paper:
Transaction costs to process a $100,000 loan are comparable to a $1 million loan, but with less profit. As a result, banks are less likely to engage in lending at the smallest dollar level. Some banks, particularly larger banks, have significantly reduced or eliminated loans below a certain threshold, typically $100,000 or $250,000, or simply will not lend to small businesses with revenue of less than $2 million, as a way to limit time-consuming applications from small businesses.
One Man’s Trash…
Into this void has rushed alternative lenders. These include everyone from providers of merchant cash advances and factoring agents, to peer-to-peer platforms such as Lending Club, as well as marketplaces such as Biz2Credit, Kabbage, Fundera, and Lendio.
“There is a whole category of new entrants who are providing a marketplace, facilitating the matching of willing lenders with qualified borrowers,” notes Mills. She adds that these lenders are also making advances in the way loans are underwritten, taking advantage of non-traditional sources of data–for example, account balance data–to make faster decisions than banks can.
At the same time, such lenders make up only about 11 percent of the credit facilities available to small business owners. And the lack of regulatory oversight for many of these new financing arrivals is a cause for wariness, particularly as their loans often come with interest rates that are sky high, as much as 40 percent.
“We need to have some concerns for small business owners because the rates are very high, and we might be concerned that people could be taking advantage of them,” Mills says.