August 2012 – The Future of Small Business Financing

Posted on August 23, 2012

Everyone loves small business.

At least that’s what the politicians want you to believe.

The reality is different. Small business is under attack from every quarter. Government policies favor large banks and large multinational businesses. Credit is tight and the banks favor the larger borrowers. Increased regulations stifle innovation and protect large incumbents that can afford teams of lawyers and lobbyists.

What’s the little guy to do? Waiting for the politicians to change the system is wishful thinking. Smart business people find ways to prosper in every environment.


And the current environment is not great for small firms. The Federal Reserve Senior Loan Officer survey has recently confirmed what we have suspected for some time: banks have been more generous in easing underwriting requirements for larger companies than they have been for smaller companies. Paynet, which maintains data on 17 million small business loans, reports that lending conditions for small firms have deteriorated in recent months after two years of bounce back from the 2009 bottom.  For additional details go to the full article on Capital Matters.


Financial Market Risk
And there’s a risk that things could get a lot worse for businesses that don’t tie down their financing soon.  We just published an article on Seeking Alpha that has received a great deal of attention with more than 14,400 page views so far. Our thesis is that the Fed’s zero interest rate policy has led to a situation where longer term treasury bonds are trading at yield levels that provide a spread to inflation far below the historical norms. Markets eventually return to their mean and often overshoot it so there is growing risk in the longer term debt market. Our concern is two-fold. First, that individual investors need to be aware of the potential impact of this return to the mean … read the rest

The Future of Community Banking

Posted on August 19, 2012

In a recent announcement, First Virginia Community Bank announced the acquisition of 1st Commonwealth Bank, a small de novo bank started in 2009.  The transaction is pending regulatory approval and will be treated as stock for stock and the value to book was about 97%.

This will become a common trend over the next three to five years with a Wall Street projection that some 20% to 30% of banks will be merged before it is all done.

Why is this typical of what the future will hold?

First, the constant pressure of maintaining high regulatory capital ratios requires banks to reach certain efficiency ratios sooner rather than later to be profitable,

Second, the access to capital for all banks is limited, at best.  Hence, there will be a “survival of the fittest” banking industry environment with each bank striving to be the dominant bank in its market(s),

Third, to be competitive and sufficiently profitable to maintain such a position in the market, community banks must achieve a minimum asset size of around $1 billion.

What is behind the higher regulatory capital ratios?

The lingering effects of the economy and the Great Recession have made a significant impression on all banks, especially those serving their communities.  The asset devaluation of real estate (both residential and commercial) took a significant chunk out of capital and there are no expectations for a quick recovery.  Hence, many banks are in a precarious position in which the future is still unknown.

Further compounding this is a recent announcement by the Federal Reserve that suggested it would likely implement Basel III  and make its capital requirements applicable for all banks, large and small.  Simplified, Basel III sets new rules for the capital ratios based on a bank’s complexity of risk-based assets.  In the past, there were only bucketed assets … read the rest

A Swan Blacker Than The Darkest Night

Posted on August 18, 2012

Interest Rates Rise at 2652% Annualized Rate! That’s probably a headline you will not see in the Wall Street Journal and it’s certainly a bit over the top, but those are the facts. From July 18 to August 17, the interest rate on the two-year Treasury jumped from .22% to .29%. That’s a 32% one month increase and works out to an annual jump of 2652% if you compound the increase monthly. Just to be fair the ten-year rate “only” rose from 1.52% to 1.81% or about 19% over the same period. With the magic of compound interest that generates a far more benign 713% annualized rate rise.

If you haven’t already done the math, those growth rates would take you to a 43.8% annual interest rate on the two year a year from now and a 12.9% interest rate on the ten year at that point. Of course that is not going to happen. Most likely we’ve just seen a random fluctuation in an overbought market. The Fed has promised to keep interest rates low for an extended period after all.

We’ve been saying for some time that the seeds have been planted for a move into a period of stagflation comparable to what we saw from the mid-1960’s and the 1970’s. That move, which transformed the benign inflation of the 1950’s to a raging inferno by the end of the period, eventually took Treasury rates for the 10 year to unheard of levels of 15% by the end of the 1970’s. This resulted in a collapse of the bond market and the eventual failure of entire savings and loan industry in the United States in the 1980s.

The United States and most of the developed world have benefited tremendously over the past 30 years from a steady drop in long-term bond rates.… read the rest

Financial Innovation Aids Small Business Borrowers

Posted on August 15, 2012

The most recent Federal Reserve Senior Loan Officers Survey conducted at 64 large banks confirms what we have suspected. After a long period of tightening, loan standards have stabilized and for larger borrowers they have loosened slightly. The survey provides less hope for smaller borrowers, shown in red on the chart below.

(Click on Image to enlarge)

This confirms data we published previously showing that small business lending has entered into a choppy period in 2012 after seeing moderate improvement from the 2009 lows during 2010 and 2011. Things are only likely to get worse for smaller borrowers as their natural allies, the community banks, struggle with maturing underwater CRE (commercial real estate) loans, continued pressure from their regulators and rapid industry consolidation.

FDIC data shows that bank credit availability is likely deteriorating for many cash starved small businesses. From December 31, 2010 to March 31, 2012, C&I (commercial and industrial) loans at banks over $1 Billion, i.e. those that focus on lending to large multinationals and mid-sized domestic firms, grew approximately 20% from $1 Trillion to $1.2 Trillion. For banks under $1 Billion, i.e. those most focused on small business lending, C&I  loans actually dropped 6% during the period from $110 Billion to $103.5 Billion.

We increasingly see smaller firms struggle to obtain funding if they do not have adequate hard collateral (equipment, inventory or receivables) or if the owners don’t have personal assets to pledge to support the loans. If you are a small business with a capital need to support a growing business, you’re asking “what options do I have?” Recently some innovative non-bank financial services firms have stepped into the breach and are beginning to offer new forms of small business finance based not on specific collateral, balance sheets or income statements, but on a company’s proven ability to generate … read the rest

QE Anyone?

Posted on August 10, 2012

If anyone doubts we are moving to more monetary accommodation, take a look at the excerpt below from last night’s U.S. Financial Data release from the St. Louis Fed. The lower right hand corner reflects the most recent trends.

In June, we posted an article indicating a seeming correlation between the trend in direction and magnitude of U.S. M2 growth and U.S. economic activity. The decline in the M2 growth rate has now turned, and is headed up again, as you can see below, but the turn is not as dramatic as the growth in the Monetary Base.

We’ve previously stated our concern that the U.S. could be heading into a period of rapidly increasing inflation, similar to that experienced in the early 1970s that led to many years of stagflation, only ending with Mr. Volcker’s monetary castor oil. We’ve got all the ingredients, including this summer’s rapid runup in commodity prices. The past twelve month the GDP price deflator has dropped from 2.4% to 1.9% on an annual basis, averaging a bit above the Fed’s 2% target. 2-3% is in the range where the 1970’s inflation began to take off. Yet, we’re in a period where many, if not most, observers have been talking recession and increased likelihood of deflation. Real inflation will come as a black swan for many, with significant implications for both fixed income and equity markets.

Could the current round of easing be the spark that finally ignites the inflationary flame? There are lots of reasons to suspect that’s possible. Calculated Risk just supported a growing belief that housing may finally be bottoming. Declining home prices have been a primary force that’s kept inflation in check for the past few years. Add to that a renewed commodity spiral, annual wage inflation in China hitting 13-15% and evidence that the read the rest

U. S. Small Businesses Heading Into Choppy Waters

Posted on August 9, 2012


Source: Paynet

Small business lending has grown steadily since the end of the recession.  The Thomson Reuters/PayNet index focuses on loans to borrowers with total indebtedness under $1 million.  In a related story it was reported that preliminary June data not reflected in the chart above shows a sharp 5% drop in small business lending.  The article paints a rather gloomy picture for small businesses and the economy as a whole.

PayNet President William Phelan explained, “Businesses and bankers should prepare for more slowdown. Now might be the time to consider adding capital. Credit supply is high and interest rates are incredibly low.” Phelan added “banks should strengthen credit quality to prepare for further slowdown. Stress Tests show that a full blown recession means small business failures could triple.”

According to Paynet the Thomson Reuters/PayNet Small Business Lending Index (SBLI) measures the volume of new commercial loans and leases to small businesses indexed so that January 2005 equals 100.  Because small businesses generally respond to changes in economic conditions more rapidly than larger businesses do, the SBLI serves as a leading indicator of the economy. The index is a highly correlated leading indicator of the GDP by 2 to 5 months.

There is some good news in the report.  Small businesses have been steadily improving their balance sheets since the beginning of the recession and loan delinquencies are at historically very low levels, with severe delinquencies much lower than 2005 the first year for which data is available.  However, the report goes on to say that small business investment rates are lower than in 2005 as companies pay down debt and build cash.  Banks are under-loaned with loan to deposit ratios of 60-70% and are competing hard for the few high quality loans that are available.  While businesses are being cautious in this difficult … read the rest