PayNet President Bill Phelan says to continue expansion at low risk, businesses need to start borrowing again.

On May 20, the U.S. Small Business Administration inaugurated National Small Business Week – an annual collection of events championing the strength of American entrepreneurship and the powerful role these enterprises play in securing the nation's standing as a global economic powerhouse.

If you happen to be a small business considering a search for expansion financing this summer, however, chances are you're not feeling very powerful.

There is reason to be cautious. If you read the national newspapers, the dominant narrative goes something like this: Companies want money, and lenders aren't giving it to them.

There is certainly evidence to suggest that's the case – at least in some regions and among certain sectors of the economy. A major poll conducted at the beginning of the year by the American Sustainable Business Council, Main Street Alliance, and the Small Business Majority revealed that a whopping 90% of small-business owners nationwide cite the availability of credit as a problem, with 60% saying they have personally faced difficulty when trying to obtain loans to grow their businesses.

More recently, according to a report from Biz2Credit – which was released at the beginning of May – loan approvals at big banks fell to 10.6% in March, a full percentage point below the same period in 2011, and approval ratings at small banks and credit unions didn't fare much better. 

Other reports suggest funding is particularly tight for small manufacturers. Recently, CNN reported on a survey of 268 factory owners conducted by the manufacturing group MFG.com that found more than a quarter of respondents blame lack of access to capital for their inability to hire new workers and manage growth. The report quoted Matt Henderson – president of Performance Machine & Manufacturing – who said he had trouble securing an expansion loan for $140,000 to hire workers and launch a marketing campaign despite the fact that his revenues are up 80% this year. After being turned down flat by Bank of America, Henderson says he was offered a loan with “unreasonable” terms – including a 6-7% interest rate and a personal guarantee – from his new bank, Regional Finance. 

“Any prudent business owner knows that cash is king,” MFG.com CEO Mitch Free told CNNMoney. “When funding is tight, you go into preservation mode, you restrict appetite for expansion and this hurts the economy. We all feel it.”

Yet these anecdotal reports are contrasted by a ream of data that seems to suggest there are other factors at work keeping capital out of the hands of small businesses; and if the evidence is to be believed, the problem is much more complex than a simple issue of supply – and business owners themselves may be partly to blame.  

A Problem of Demand

Bill Phelan, president PayNet, Inc. – a data analytics firm focused on small-business credit – says all evidence points to a lack of demand for goods and services as the cause of the current borrowing slump.

“The data is telling us very clearly that banks and leasing and commercial finance companies want to make loans, they want to put money to work, they want to put earning assets on the books, but there's just not a heck of a lot of demand from the end user, the borrowers.”

The data Phelan is referring to is the most recent Thomson Reuters/PayNet Small Business Lending Index, which found that entrepreneurs pulled back their borrowing considerably in March, following a spike at the end of 2011. Phelan calls the end-of-year borrowing surge “artificial” because it was largely tied to the expiration of bonus depreciation tax benefits.

According to PayNet's analysis of data from leading U.S. lenders, seasonally adjusted originations declined 3.7% in March compared to February. The report also notes that the first quarter of 2012 represents the first three-month period in more than a year that borrowing has been consistently stalled.

But relying on borrowing levels alone doesn't offer much insight into the underlying causes of the decline, so Phelan says PayNet took its analysis one step further by tracking new loan applications and bookings.

Phelan says an analysis of credit applications for 2008 through 2011 shows steep declines in new applications in 2009 and 2010 with a leveling off in late 2010 and 2011. Since then, there has been only a slight tick upwards in new credit applications, he says.  

“It's clear that there isn't a lot of demand for credit because if there was you would see higher credit applications,” Phelan explains. “So there is still this demand question over the economy: Why aren't businesses accelerating more aggressively after the recession?”

With credit applications stagnant, Phelan says loan booking rates are “jumping way up,” and are higher now than they were prior to the recession – meaning banks and lending firms are approving more applications.

“We had this period during the recession where booking rates decreased, but then lenders got hungry to put on earning assets,” Phelan says. “So, now you've got credit applications still low, and you have booking rates above pre-2008 levels, and that tells us that the supply is there because the booking rates are up.”

Taken together, these two indicators – fewer credit applications and higher booking rates – paint a picture of an eager lending community confronting a small business sector reluctant to take out new loans. And, as lenders compete for slow volume growth, deal spreads are tightening which may potentially result in lenders not getting compensated for risk. The results of a recent Wells Fargo/Gallup poll seem to back up at least half of that assessment.  According to the survey of 603 small-business owners released on May 16, nearly one in three small businesses that have borrowed in the past have less debt now than they did a year ago. And while 20% say they have had trouble accessing the credit they need to grow over the past 12 months, the vast majority report not needing additional credit or say that their business has been able to obtain all the credit it needs. 

To round things out, PayNet analyzed credit terms going back to 2008 to determine if tight loan restrictions – like those cited by Performance Machine & Manufacturing's Matt Henderson – were simply scaring away would-be borrowers. On the contrary, says Phelan, our data suggests there has actually been a “widening of the credit box” since 2011 – characterized by longer loan terms, which indicates looser requirements.  

In fact, in its survey of senior loan officers for the first quarter of 2012, the Federal Reserve noted that banks have been loosening restrictions on everything from mortgages to commercial and industrial loans.
 
An Environment of Uncertainty

If lenders are indeed eager to put more capital into the marketplace, then the question is: Why aren't small businesses taking advantage of it? 

While it's impossible to ignore the fact that some small businesses are having trouble getting the credit they need, it's clear that on a more macro level, an undeniable element of fiscal caution is pervading the U.S. small-business sector. But determining what's driving the caution is trickier. By all accounts the economy is in a steady, if fundamentally unsatisfying recovery. U.S. gross domestic product grew throughout 2011 – hitting 3% in the fourth quarter and
dropping slightly only in the first quarter of 2012. Meanwhile, unemployment has been gradually declining the past two years and is expected to remain close to the April 8.1% level through the rest of the year.

According to Phelan, “by any measure, risk is at very low levels,” as evidenced by historically low delinquency rates for small business credit and the overall financial health of U.S. businesses. “Given that financial risk is this low you would expect to see a little more risk taking by small businesses. But they are not,” he says. “They are still hunkered down.” 

Phelan says the message he's getting from entrepreneurs is that uncertainty over future shifts in national policy – including how the new health care law will affect their businesses – is keeping many small business owners in the safe zone. Phelan explains that without knowing what new regulations will be imposed, entrepreneurs cannot anticipate the impact such changes will have on their bottom lines. This is supported by a Bank of America survey of small-business owners released in the middle of May which cited the rising cost of health care, the effectiveness of U.S. government leaders and the recovery of consumer spending as their primary concerns.

“Business owners can play under any set of rules, they just need to know what the rules are,” he says. “We don't need to hold their hands, we need to give them certainty and clarity about future policies. If they don't have that kind of certainty, they're not going to go out on a limb and invest in a four-year project.”

The good news is that confidence appears to be slowly creeping back into the small-business sector. The National Federation of Independent Business reported that its Small Business Optimism Index rose two points in April to its highest reading since December 2007. What's more, according to Phelan, since the first quarter of last year the economy has been in a “green zone” of the business cycle characterized by an environment of expansion coupled with low risk. 

“A similar green zone in 2005 and 2006 lasted about nine quarters,” says Phelan, “and we are hoping this one will last just as long, but that will be dependent on a whole bunch of factors. You'd need a crystal ball to figure them out.”

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