Office of Advocacy

This report contains research prepared by the Office of Advocacy of the U.S. Small Business Administration. The opinions and recommendations made herein do not necessarily reflect official policies of the U.S. Small Business Administration or any agency of the U.S. government. For further information, contact the Office of Advocacy, U.S. Small Business Administration, 409 Third Street S.W., Washington, DC 20416. Published January 1996.

Foreword

The importance of small business to our national economy cannot be overstated. America's small businesses, some 22 million strong, employ about 54 percent of the private work force, contribute 47 percent of all sales in the country, create two out of every three new jobs and produce two and one-half times as many innovations per employee as do large firms. Small firms keep our market-based system efficient and successful; they keep our nation competitive in global markets. Commercial banks are important generators of credit to small business:

Bank credit (outstanding as of June 1995):
Commercial and industrial loans $98 billion
Commercial mortgages $66 billion
Total bank credit $164 billion


(For example, finance company lending to small firms is estimated at $91 billion. SBA guaranteed lending that is included in bank and finance company lending is $24 billion. SBA guaranteed loans in the secondary market are near $10 billion.)

Since commercial banks play such a vital role in maintaining the health of the small business sector and the nation's economy, the impact of the increasing availability of credit and falling interest rates, or the opposite, will have magnified effects on small firms, as opposed to large firms. Large firms have options not available to small businesses such as access to the stock, bond and commercial paper markets. It is because of the importance of commercial banks to small businesses' survival and growth that the Office of Advocacy has undertaken this second study on the lending behavior of the nation's commercial banks. As with the first study, published in December 1994, the findings are being released on a state-by-state basis. Every commercial bank in each state has been rank-ordered to help depositors and borrowers have a clearer picture of small business lenders in their respective states. Two important objectives of this project are (1) to provide information not otherwise available in the marketplace to increase competition among lenders for increased business with the engine that is driving the U. S. economy small business; and (2) to give small businesses information about where to shop for credit, as well as information that may help them negotiate favorable credit terms In doing this, the SBA's Office of Advocacy is relying on a basic rule of economics that information rationalizes markets and makes them more competitive; the more competitive the market, the more efficient the market will become, providing more and better quality services. The approach addresses both the demand and supply sides of the credit market equation.

Numerous requests for the data published in late 1994 provided significant evidence of the need for and interest in this information. Bth borrowers and lenders requested the data, and this interest was reinforced by the business media. Following release of the study last year, the Wall Street Journal, and Inc. and Entrepreneur magazines all did stories on banking, using some of our ideas and concepts. Entrepreneur magazine published two issues listing the top banks from our studies. Numerous regional business and local newspapers, like The Washington Post, also did articles listing the top banks in their respective communities. It is clear that the market has no other mechanism to provide this overview of credit and bank lending patterns, yet such information can be used profitably by both borrowers and lenders. Subsequent analysis of the data showed that banks that were small-business-friendly were more profitable than banks that made few small loans. This insight casts doubt on the working assumption used by many banks that loans to small businesses are less profitable.

Comparison of this year s data with the first study indicates that credit to small firms has increased by more than $8 billion. This is significant. While it is too soon to tell how extensively borrowers and lenders are using the data, it is clear that some large banks have started providing extensive services to new firms, helping them with development of business plans, and the gathering of other necessary information required for loan approval. This is a welcome innovation and is evidence of an increased awareness in some banking sectors of a previously untapped profitable lending market small business.

Some aspects of the credit environment will need further scrutiny. For example, the Office of Advocacy will be exploring whether bank merger activity this past year is having an adverse impact on the availability of bank credit to small businesses. I would like to thank all who commented on our research efforts to improve the efficiency of the credit markets for small loans, particularly the bankers and banking associations, small business owners and organizations, bank regulatory authorities, and the House and Senate Banking and Small Business Committees. Your comments have contributed to a better understanding of the complexities of the credit markets.

Jere W. Glover
Chief Counsel for Advocacy
U.S. Small Business Administration


Introduction

New information from the National Survey of Small Business Finances, jointly funded by the Federal Reserve Board and the U.S. Small Business Administration s Office of Advocacy, show how important the commercial banking system is to the credit needs of small firms.1 For example, two-thirds of all small businesses that borrow, get their funds from commercial banks. Twenty-one percent go to finance companies for their credit needs. Only 14 percent of small-firm borrowers get their credit needs met by family and friends.

As firms grow, their reliance on the commercial banking system increases. Of the firms that borrow, the following percentages obtain their financing from commercial banks:

60 percent of the 0 to 1 employee firms,
64 percent of the 2 to 4 employee firms,
71 percent of the 10 to 19 employee firms,
87 percent of the 100 to 499 employee firms.


It is crucially important for the health and growth of small businesses to understand which banks are willing to meet the credit needs of small firms and which banks invest their resources elsewhere. Such information will help small businesses shop for credit and save valuable time.

The total amount of small business loans (loans under $250,000) outstanding as of June 30, 1995 was $164 billion: $98 billion in commercial and industrial (C&I) loans and $65 billion in real estate loans. Small business loans were 20 percent of total loans, 19 percent of C&I loans and 22 percent of real estate loans. From 1994 to 1995, the number of small business loans increased by 8.9 percent or 442,441 loans; the dollar amount increased by 5.4 percent or $8.3 billion. Clearly, the credit market was expanding. That is good news for all borrowers.

Why are some commercial banks more small-business-friendly than others? That is a question for additional research. But what the 1994 research did indicate is that small-business-friendly independent banks are more profitable than banks making few loans to small firms. Another significant finding was that investing in small loans can be as profitable as investing in any other assets after adjustments for differences in risk.2

Background to the 1995 Analysis

The United States Congress has mandated that, as part of a lending institution s call report to federal banking authorities, information be reported by loan size for loans under $1 million.3 The Congress also mandated that the data be available for public use and analysis.

Various small loan data the number and dollar value of small business loans outstanding, the dollar value of small business loans relative to a bank s total assets, the dollar value of small business loans relative to total deposits and total business loans enable researchers to rank commercial banks' small business lending activities by bank size within each state. Banks of different sizes rank high in different categories. For example, smaller banks make a larger percentage of small business loans, but larger banks outrank smaller banks in the sheer number and value of small loans (see Table 1).

It is important to note that the call report data tell only part, albeit an important part, of the story about lending to small business. For example, call reports do not contain separate information on SBA-guaranteed lending activity. Banks that are very active SBA lenders but sell the guaranteed portion of their loans in the secondary market are likely to be underrepresented in the rankings since their call reports contain only information on the unguaranteed portion of their SBA loans to small business. It is hoped that future data will provide specific information on SBA-guaranteed lending activities.4 Also, some banks may be making small business loans through credit cards, second mortgages, or other forms of consumer credit. These banks, too, may not rank high in the listings. Finally, call reports do not reflect demand conditions; that is, no amount of small business friendliness on a bank s part will make up for lack of demand or low demand for small business loans. (A bank without branches may limit the geographic area of its lending activities to only one community or part of the state. This appears to be the case for many top-rated banks.)

Thus, it is difficult to say categorically which banks are best in lending to small business. What can be said is which banks are best according to information presented in the call reports as analyzed in this report.

A major goal of this project is to provide information for users of banking services to help them make better-informed market decisions. Entrepreneurs will see which banks in their communities make small loans; depositors will be able to determine if their banks provide small loans to businesses.

Moreover, if banks recognize that their lending behavior is being monitored by advocates of small business, their lending attitudes may change and competition to meet the credit needs of small firms may increase. Small business owners may find they have greater access to traditional business loans and can avoid using more expensive credit card debt or mortgaging their home. The hoped-for result is that more credit will be available overall to the nation s small businesses, enabling them to contribute more to the nation s economic growth.

Attached is a table listing all the banks in one state and their lending activities to small business. (For the purposes of this study, a small business loan is defined as a loan of less than $250,000.) The data used in developing the table come from the June 1995 call reports compiled by all federally insured commercial banks and submitted to the federal regulatory banking authorities.5

Explanation of the Data

In this study, the overall performance of each commercial bank is based on the sum of the decile value of five variables:

the dollar value of small business loans relative to total bank assets;
the dollar value of small business loans relative to total business loans;
the dollar value of small business loans relative to total deposits;
the dollar value of small business loans; and
the total number of small business loans.


An explanation of the data follows. Readers may find it beneficial to refer to the sample table on page 9.

Column 1. The summary statistic found in the first column is an aggregate measure of small business lending activity, the sum of the decile rankings found in columns 2 through 6. (A decile ranking is a measure of where the individual bank falls in the distribution of the statistic defined by the column. Decile rankings range from 1 to 10, with 10 meaning the individual bank is in the top 10 percent of all banks within the state.) A summary statistic value of 50 indicates that the bank is in the top decile in each of the five categories. A value of 5 indicates that the bank is in the bottom decile in each of the categories. The average value for all states for this statistic is 27 out of a possible 50.

Column 2. This column measures the ratio of small business loans to total bank assets. A ranking of 10 means that the bank is in the top decile of the state loan-to- asset distribution. The bank has an outstanding record in lending to small business; it is willing to risk a larger portion of its assets in small business lending. If the number is a 2, it means the bank falls in the next to the lowest decile for this variable, that is, among the lowest 20 percent of all banks in the state. The conclusion to be drawn is that this bank has not committed much of its capital to small loans. The average small business loan-to-asset ratio for all states is 11 percent (see Table 1).

The highest loan-to-asset ratio for any bank in 1995 was 66 percent, clearly an outstanding record in supporting smaller firms. At the opposite end of the distribution, 75 percent of the banks had loan-to-asset ratios of less than 1 percent.

Column 3. The third column measures the decile ranking of the ratio of small business loans to total business loans. The sample table entry 9 means this bank falls within the second highest decile. Between 80 and 90 percent of the bank s lending is in small loans. The maximum value of this ratio is one, meaning that all loans are small loans of less than $250,000, and this is the case for many small banks. The average small business loan to total business loan ratio for all states is 66 percent (Table 1).

Column 4. This column gives the decile ranking of the ratio of small business loans to bank deposits. If the number is close to 10, it means that the bank ranks near the top in reinvesting its deposits in the community s small firms. Technically, there is no geographical information about the borrower, but most researchers accept that if the loan is small, it is more likely to be invested locally.

The maximum small business loan to deposit ratio is 75 percent; however, the average is only 13 percent (Table 1).

Column 5. This column shows the decile ranking of a bank's dollar value of small business loans outstanding.

Column 6. This column measures the bank s decile ranking for the total number of small business loans.

To repeat, the summary statistic is the sum of the decile rankings found in columns 2 through 6. A summary statistic value of 50 indicates that the bank ranks in the top 10 percent in all categories of small business lending (where small business lending is defined as all commercial, industrial, and commercial real estate loans of less than $250,000). A value of 5 indicates the bank ranks in the bottom 10 percent in all categories.

Additional Data

Information provided in columns 7 through 12, though not figured into the summary statistic in column 1, offers additional data about an individual bank's small business lending attitude or activities.

Column 7. Here the asset size class of the bank is defined. The classes are:

Under $100 million
$100 million to under $300 million
$300 million to under $500 million
$500 million to under $3 billion
$3 billion and over


The average decile values of the summary statistic for the different bank size categories are:

Under $100 million26.8
$100 million to $300 million29.4
$300 million to $500 million28.5
$3 billion and over24.5


Column 8. This column measures how well a bank is doing in its own asset size class relative to the summary ranking found in column 1. Thus, a 1 in this column means that the bank ranks first in its asset size class. A 10 means that it ranks 10th in its asset size class. The number of banks in each asset size class can be found at the end of this report. The total includes all commercial banks filing call reports.

Columns 9 and 10. These two columns list measures of the dollar amount of small business loans in thousands (column 9) and the number of small business loans made by the bank (column 10) for loans of less than $100,000.

Columns 11 and 12. Displayed here are two additional decile rankings of loan-to- asset ratios: column 11 shows the ratio of loans under $100,000 to the bank s assets; and column 12 displays the ratio of loans under $1 million to the bank s assets.6 This information allows a small business to find a bank that ranks high in the desired loan size category. A firm looking for a $50,000 loan might be better served by banks making more loans under $100,000 than a bank concentrating on $1 million loans.

Column 13. This column is the decile ranking for the ratio of total small business and small agricultural loans (under $250,000) to the bank s total assets.

Limitations of the Study

Call reports tell only part, albeit an important part, of the story about bank loans to small business. For example:

-- Banks may provide lines of credit to small firms in their region. If the line of credit is not drawn upon, a small loan would not show up in the call reports

-- A bank may issue consumer credit cards to small firms with the idea that the cards should be used for working capital, to buy office equipment, or as lines of credit.

-- A larger bank may send the small business owner to its consumer loan division; then the loan would not be recorded as a business loan.

-- A larger bank may send the business person to a subsidiary finance company. In that case, the loan would not be recorded in the bank s call report.

SBA loans that are sold in the secondary market will be recorded in the number of loans. However, only the non-guaranteed amount of these loans will be included in the dollar value of small loans in the call report.

Loans to small businesses are often made in the form of a second mortgage on the business owner's home. Many business owners use personal credit or home equity loans for business purposes. Again, these would not necessarily show up as small business loans in the call reports.

The call report data used in the attached tables are all that is available to the public at this time but provide useful information for both lenders and borrowers. As more precise information is available, it will be released so that depositors and borrowers can make more informed decisions about which local banks are small-business-friendly.

Discussion

There are debates among researchers on how best to measure which banks meet the needs of small business. One debate revolves around whether to use a single statistic like that found in column 2 or in column 4. A ranking of banks according to the small business loan-to-asset ratio (column 2) will show small or medium-sized banks dominating the listings. If the ratio of loans to total loans (column 3) or the ratio of loans to deposits (column 4) is used, a different set of smaller banks is likely to dominate the ranking. A rank order of the banks by either the value of small business loans (column 5), or the number of small business loans (column 6), will tend to be dominated by large banks.

What is clear from various bank studies is that all banks, regardless of size, are important in satisfying the lending needs of small firms. In adding up the decile rankings of all five categories it is assumed that all are equally important in meeting the lending needs of small firms. And indeed a bank s rank may well change if additional statistical data are added or deleted.

To help analysts, a broad range of data has been included so that users of the tables can create a set of rankings that suit their individual needs. For example, if a small business needs the services of a large bank, the rankings in columns 5, 6, or 8 may be the most appropriate ones to consider.

In addition, there is a debate over whether national rankings should be used, as opposed to the state rankings found here. While it is true that large business borrowing and large bank lending take place in national or regional markets, small business borrowing is normally in a local marketplace. It therefore seemed appropriate and more useful to users of the information to use rankings within states.

Future Activities

Future research will explore how bank mergers and acquisitions are changing the availability of loans to small business. The bank profitability study of 1995 (see note 2) will be updated. In March 1996, the Office of Advocacy will release information on the banks that most improved their rankings between the call reports of 1994 and 1995.

Suggestions on how to improve the analysis are welcome. Send comments to the study director, Dr. Robert E. Berney, Chief Economic Advisor, U.S. Small Business Administration, Washington, DC 20416; telephone (202) 205-6926; fax (202) 205- 6928.

Conclusion

For the second year, the Office of Advocacy is releasing its analysis of call report data on the lending activity of some 10,000 individual commercial banks. The information is catalogued on a state-by-state basis to enable depositors and borrowers to make better decisions about banking services in their respective states. The goal of the study is twofold: (1) to improve the efficiency of the commercial banking credit markets, which will make more credit available to small business borrowers. Knowing that some successful banks are actively making small loans to small businesses should encourage other banks to compete for the small loan customer; and (2) to give small businesses information they can use to find a bank willing to meet their credit needs. The study provides information in a composite format that allows both lenders and borrowers to compare bank performance a comparison that is not otherwise available in the marketplace.

Reactions to the Banking Study

We appreciate your planned press release for banks such as ours. A joint effort utilizing our resources, and yours only helps ensure that we reach our targeted market.
First National Bank of Bar Harbor, Bar Harbor, Maine

All too often, the bad news receives the attention in the media. We appreciate your agency's efforts in seeking to identify means by which the positive news can be recognized. Thank you for your observations of our efforts to lend to the small business community in our area.
The Twentieth Street Bank, Huntington, West Virginia

It has been the continuing vision of our bank that we return deposits to their sources . . . in the form of loans in our community. It is gratifying to have others recognize that we have had some success in attaining our goal.
Douglas County Bank,Lawrence, Kansas

ENDNOTES

1. Rebel A. Cole and John D. Wolken, Financial Services Used by Small Businesses: Evidence from the 1993 National Survey of Small Business Finan-ces, Federal Reserve Bulletin (July 1995), 629 667.

2. James Kolari, Robert Berney, and Charles Ou, The Effects of Small Business Lending on Bank Profits and Risk, report no. PB95-255691 (Springfield, Va.: National Technical Information Service, 1995).

3. Call reports, officially known as Consolidated Reports of Condition and Income, are quarterly reports filed by financial institutions with their appropriate bank regulator. The call reports provide detailed information on the current status of a financial institution. Beginning in June 1993, financial institutions were required to report the number and amount of small business loans. Loan size information was mandated by Section 122 of the Federal Deposit Insurance Corporation Improvement Act of 1991. Initially, the banking regulators had proposed to collect the data by size of business and by size of loan. To lessen the reporting burdens on financial institutions, the final requirements mandate the reporting of small business lending data by loan size only for loans under $1 million. The SBA s Office of Advocacy purchased the June 1994 and 1995 call report data from the National Technical Information Service.

4. Lists of banks that have preferred and certified lending status are available on request from the SBA s Office of Advocacy. Preferred lending status means that the bank has been given the full authority to guarantee SBA loans to qualified business owners without SBA review. Some 350 banks have this status. Certified lending status means that an SBA loan officer will rely primarily on the bank s analysis. Some 1,350 banks have this status.

5. Loans under $250,000 were selected as a measure of small business lending activity in preference to loans of less than $1 million because the size of the borrower generally increases with the size of the loan. Local subsidiaries of large businesses are more likely to borrow $1 million than $250,000. To minimize white noise in the loan size data, a loan size was selected that may be small for many small businesses. (For example, the maximum loan size for an SBA-guaranteed business loan is $750,000.) But most of the borrowers in the $250,000 loan size will be small. In addition, there is an 80-percent correlation between the $250,000 and $1 million loan size series; thus most of the information in one series will be included in the other series.

6. These two loan-to-asset ratios are correlated with the loan-to-asset ratio in column 2; therefore the results are not dependent upon the assumption that small business lending is less than $250,000. For example, a preliminary regression using the 1994 data shows an 80-percent correlation between the less-than-$250,000 loan size and the less-than-$1 million loan size.

TABLES

Table 1. Average Data on Small Business Lending by U.S. Banks for 1995
               Small Business Loans to: a
                                        Total     Small Business
Size Category                           Business     Loans
of Bank             Assets    Deposits  Loans     Valueb  Number c
_____________________________________________________________________
< $100 million       13.1       15.3      77.6      $6.5      191
$100-$300 million    11.113       .0      56.5      $17.5     479
$300-$500 million     8.510       .2      39.1      $31.3     849
$500 mill-$3 billion  6.3        8.0      30.1      $66.7     4,222
> $3 billion          3.2        4.8      17.8      $247.4    8,602
All banksd           11.4       13.5      65.8      $24.2     947
_____________________________________________________________________

a. Ratio expressed as a percent.
b. In millions of dollars.
c. Thousands of loans.
d. Averages for all states.
Source: U.S. Small Business Administration, Office of Advocacy from
the June 1995 Call Reports.
Sample table entry
[not available in text format]
Key to Tables
Primary Data:
(1) Summary statistic: the sum of columns 2 through 6.
(2) The decile value of ratio of small business loans (of
less that $250,000) to assets.
(3) The decile value of the ratio of small business loans
to total business loans.
(4) The decile value of the ratio of small business loans
to total deposits.
(5) The decile value of the total amount of small business loans.
(6) The decile value of the total number of small business loans.
Additional Data:
(7) Asset size class.
(8) Ranking in asset size class (1 is the highest).
(9) Value of small business loans (less than $100,000) in thousands of dollars.
(10) Number of small business loans (less than $100,000).
(11) Decile ranking of $100,000 loans to assets.
(12) Decile ranking of $1 million loans to assets.
(13) Decile ranking of small (less than $250,000) business
and agricultural loans to assets.