Analysis of Small Business Lending in Texas. Special Report to the Finance Commission of Texas

Transcription

1 Analysis f Small Business Lending in Texas Special Reprt t the Finance Cmmissin f Texas

2 ! Cnducted in the summer and fall f 2001! Fcusing n 4 issues related t small business lending: Availability f Credit; Pricing and Terms f Credit; Quality f Credit; and, Lending Practices and Brrwer Experiences.! Prvides results f a statistically valid survey f 1567 small businesses thrughut Texas.! Designed after a series f studies by the Federal Reserve Bank ver the past decade and a half.

3 GENERAL CONCLUSIONS! General cnclusins are representative at the statewide level and within regins.! Exceptins t every finding n dubt exist. Three general cnclusins are derived frm this study. 1. Access t lending pprtunities is primarily thrugh traditinal banking institutins; hwever, many small businesses in Texas have turned t a variety f ther surces t btain lans r their equivalents. 2. Access t lending is bradly available even amng thse small businesses that exhibit the mst extreme set f cnditins that wrk against lan apprval. 3. Within sub-units f the state there exist varying patterns and cnditins that lead t differences in hw small business lending is cnducted.

4 GENERAL CONCLUSIONS Many differences in the lending prcess are easily attributed t issues assciated with:! the lan applicant s bank relatinship,! the credit histry f the firm and its wner,! the ability t supprt debt service,! lack f a business plan r! general lack f revenues. Sme differences are related t the type f lan applicatin where cllateral can be used t secure the debt. The access t debt lending can als change if the brrwer lks t nn-traditinal surces such as credit card cmpanies and is willing t accept higher rates in lieu f meeting all bank cnditins f credit supply.

5 GENERAL CONCLUSIONS! The prepnderance f small businesses in Texas are: retail and service riented, generating revenues less than $500,000, likely t have small payrlls f less than ten emplyees under a sle prprietrship structure.! We find that the brder area f Texas has mre issues that are likely t wrk against access t debt finance. This cnditin, hwever, cannt be assessed withut understanding the brder mre generally. Additinal assessment f the cnditins in the brder is called fr as ne cnclusin f this study.! Wmen, especially minrities, are grwing in the small business sectr. The data suggest prblems related t availability f credit fr wmenwned firms, but mre clsely t the way these businesses maintain recrds and apprach the verall credit picture. Wmen-wned firms in the sample d nt reprt practices by lending institutins that suggest they are treated differently than nn-wmen wned firms.

6 POLICY CONSIDERATIONS 1. Reginally there appear t be sme nticeable differences and statewide plicies must take int accunt reginal patterns. 2. State supprt f reginal capital access centers that serve as fcal pints fr training f business wners and prvide cncentrated access t small businesses fr lenders can assist in tailring t reginal-specific needs. 3. Underlying many business practices are educatinal needs that have nt been met. Prgrams that train and advance business knwledge, especially thse related t lending and the regulatins that are impsed n lenders, need t expand and new methds f utreach (n-line certificatin) shuld be encuraged. 4. Building n the abve, Financial Literacy fr small businesses in Texas shuld be a gal f civic and public ecnmic develpment institutins.

7 POLICY CONSIDERATIONS 5. Lending practices still invlve cnsiderable face-t-face effrt by lenders and brrwers. Even in light f rapid banking mergers, persnal cntacts may remain the primary methd fr assisting small business brrwers. 6. Minrity-wned businesses are prevalent in Texas and plicies must take int accunt the emerging majrity-minrity cnditins. 7. Minrity and wmen-wned businesses are pen t alternative strategies t assist them in pursuit f finance ptins and shuld be prvided access t the greatest range f services and strategies pssible. 8. Cmmercial banks dminate debt financing. Alternatives ranging frm Internet banking t a variety f finance cmpanies are emerging but are nt a significant surce f financing fr the vast majrity f small businesses in Texas. Overall, cmmercial banks remain the primary cnduit fr meeting the financial needs f small businesses. 9. With the grwth in alternative financing mechanisms (i.e., Internet banks, credit card lending, lease/financing) regulatrs must examine practices t insure that prtectin f small businesses is extended int these new areas.

8 POLICY CONSIDERATIONS 10. Small businesses remain subject t greater risk in many cases and, t the extent pssible, lending prgrams that share r can transfer risk fr lending institutins thrugh guaranteed lan prgrams r risk sharing shuld be cnsidered amng alternatives. 11. Nn-bank credit prviders shuld als be mre fully explained t small business brrwers wh may be faced with greater csts than traditinal banking pprtunities. 12. The critical nature f the issue f small business access t capital must als take int accunt the risk f small business ventures and the reality that sme businesses will nt survive regardless f debt leniency. 13. The develpment f new plicies t prvide greater assistance t small businesses must als take int accunt the rights f bank-wners and sharehlders wh have invested based n an expected return that may nt invlve expanded higher risk small business lending. Prtectin f sharehlder rights must be cnsidered as part f the prcess f prviding new pprtunities t small businesses in Texas.

9 METHODOLOGY! The study fllwed studies by the Federal Reserve/SBA. -- Mail survey was utilized t design the study and cllect data -- A standard randmized survey research methdlgy and a multi-stage research prcess.! The survey instrument was designed t cmply with the requirements f the Finance Cmmissin relating t the fur general areas f the study.! The survey prcess generated 1567 useable respnses, permitting evaluatin at levels f significance greater than the required 5 %.! The target ppulatin fr this study was defined by the Finance Cmmissin as nn-agricultural, nn-depsitry, fr-prfit small businesses perating in Texas with 100 r fewer emplyees.

10 METHODOLOGY! Using the Cunty Business Patterns database cllected annually by the U.S. Census Bureau, 453,872 firms in Texas met the definitin established fr this study.! Based n Cunty Business Patterns, the state s small business cmmunity is classified in tw basic ways: 1) gegraphic lcatin 2) industrial classificatin.! The gegraphic distributin f small businesses can be cnsidered in a variety f ways, but fr the purpses f this study were subdivided int three regins: 1) urban/nn-brder; 2) brder; 3) nn-urban/nn-brder.! The respnses were placed int five industrial classificatins f: 1) retail and services; 2) cnstructin; 3) whlesale; 4) manufacturing; and, 5) ther.! Respnses t the survey are in a pattern statistically equivalent t the distributin f small firms in the state.

11 $10,000,000 r mre $7,500,000 - $9,999, $5,000,000 - $7,499, $2,500,000 - $4,999, $1,000,000 - $2,499, $500,000 - $999,999 $100,000 - $499,999 $50,000 - $99,999 $49,999 r less Dn't knw.4% Other crpratin 30.3% Partnership Figure % Annual Grss Revenues Missing 2.1% Sle prprietrship 40.0% Sub Chapter S Crp. 6.6% 40% are sle prprietrs 60% reprt sales less than $500,000 annually Grss revenue Percent Firm Prfiles

12 Firm Prfiles Percent Less than 1 y ear 4 t 6 y ears 10 t 15 y ears 1 t 3 y ears 7 t 9 y ears 15 y ears r mre 35.9% have perated fr 15 years r mre 23.5% are minrity-wned Figure Minrity Ownership Percent 0.0 Yes N Minrity w ned business

13 % f minrities are Hispanic Firm Prfiles 20.0 Percent Hispanic Native American Other Af rican American Asian/Pacif ic Is land % are individually Owned firms Percent Yes 18.0 N Individually w ned business

14 Wman Ownership 70.0 Firm Prfiles Percent Yes N Dn't Knw Wmen business w nership 38 percent reprt wmen-wnership, abve the natinal average

15 Financial Services Uses and Lan Prcessing!Accunting System!Liabilities!Delinquencies and Credit Issues!Banking Relatinship

16 Accunting System! A clear majrity (56.2 percent) maintain an accunting system that prvides mnthly, quarterly, and year-end financial statements and tax infrmatin, representing the highest level f financial reprting sphisticatin.! Over 20 percent (21.7 percent) f respnding firms utilize an accunting system that generates nly year-end tax cmpilatins.! Lack f adequate recrd keeping may create prblems when requesting credit because f the regulatry requirements that must be fllwed.! Slightly less than 15 percent (14.4 percent) f small businesses generate nly a year-end tax and financial statement, a level f reprting which may be insufficient t meet the applicatin requirements fr certain types f credit.

17 Liabilities! Nearly ne-half f the sample (48.2 percent) have utstanding liabilities t financial institutins less than $10,000.! Overall, apprximately 70 percent (68.3 percent) f the respndents maintain utstanding bligatins t financial institutins f less than $50,000.! Ttal liabilities t all creditrs, in additin t thse wed t financial institutins, are less than $10,000 fr 38.4 percent f the sample.! Ttal liabilities, in additin t thse t financial institutins, were less than $50,000 fr apprximately 60 percent f the respndents.! The verall picture is f a debt structure that may nt seem excessive, hwever, servicing this debt can be prblematic fr small businesses, especially thse wh may be perating with small margins.

18 Delinquencies and Credit Issues! 12.6 % f the small businesses self-reprt having a credit discrepancy.! Less than 10 % reprt having filed a reprt t crrect the credit errr.! 10% reprt that reslutin f the credit errr was very easy.! Almst ne-half reprt that reslving the issue was difficult r very difficult.! Amng thse wh have dealt with credit discrepancies, ver ne-half (52.3 percent) reprt that reslving credit issues did nt ccur in a timely fashin, with disputes still pending in 11.8 percent f the cases reprted.! 75% reprt they had been delinquent in the past t creditrs.

19 Banking Relatinship! Lans were made t new custmers with n previus relatinship with the lender apprximately 25% f the time.! Lans t custmers wh had previusly had a lan with the lending institutin ccurred ver 50 % f the time.! Tw-thirds f the time the applicant makes the lan request in persn.! In less than ne-quarter f the cases the lan request is made by telephne.! In well ver 60 % there is nly ne applicatin made.! 20% reprted tw applicatins were submitted.! The reprt f nly ne applicatin in the majrity f cases suggests many businesses are, mre than likely, aware that they will qualify fr their lan request.! The primary surces f infrmatin abut brrwing are frm lcal bankers (47.4%), thrugh business relatinships (40.3%), fllwed by friends r business acquaintances (14.6%).

20 Dcumentatin and Evaluatin " At ne extreme, 27% reprted nt needing t prvide dcumentatin. " Only ne-half prvided the previus year s financial recrds. " In ne-third f the cases, three years f financial recrds were required t cmplete the lan applicatin. " Audited financial statements were necessary in ne-fifth f the cases (19.4 percent) and a business plan in 15.8 %. " In 49.1% f the cases, persnal financial recrds were requested indicating a link between persnal financial capabilities f the wner with the firm. " Surprisingly, 43.3 % had n knwledge f hw their credit was evaluated. " An verwhelming 84.6 % agreed that the evaluatin prcess was fair.

21 Institutin f Applicatin " Over tw-thirds f the credit requests were made at lcal TEXAS financial institutins with multi-state banks being the secnd mst apprached institutins (26.3%). " Small businesses als reprt the use f credit card cmpanies in 15.9 % f the respnses. " Credit cards have grwn in use amng small businesses in the last decade and undubtedly have becme mre frequently used fr shrt term financing. " Applicatin t guaranteed gvernment lan prgrams is relatively lw amng small businesses in Texas. " When cnsidered, the Small Business Administratin (SBA) is the mst ften utilized gvernment spnsred prgram by small businesses in Texas.

22 Types f Lans An examinatin f the mst recent lan applicatins shwed that: # 46.9 % were fr a line f credit, fllwed by wrking capital lans fr 14.2 % f the respndents. # Equipment lans (9.9 %) and vehicle lans (9 %) were the third and furth mst cmmn types f lan applicatins.

23 Of thse wh applied fr a lan:! Small businesses are generally very successful in btaining financing.! 82 % reprt they were apprved and funded.! The apprximately ne-fifth wh were denied credit discntinued credit slicitatin 59 % f the time and sught anther lender ne-quarter f the time (25.3%).

24 Fr thse denied credit:! The majr reasn given fr the denial was pr credit histry (31%).! Insufficient capital and earnings were cited in 21.9 % and 22.3 % f the cases, respectively.! T much debt als was assciated with denial in 22.8 % f the cases.! The lack f cllateral was reprted fr 26 % f the respndents.

25 Terms f Credit $ Over 60 % f the lans required sme frm f cllateral. $ Inventry and accunts receivables accunted fr 44.2 % f the cllateral, fllwed by vehicles and equipment (43.1 %). $ Business real estate was cntributed as cllateral in 22.9 % f the respnses. $ Other cllateral included: persnal assets f cash and securities (19.7%), persnal real estate (10.3 %) r ther persnal assets (7.2 %). $ A persnal financial statement frm the wner was required 49.1 % f the time. $ Additinal written agreements were required 21 % f the time as a supplement. $ 44.5 % f the time additinal prtectin (i.e., c-signer r insurance) was required.

26 Lan Terms The majrity f lan requests were fr less than $100,000 (62.4%), with lans between $100,000 and $250,000 making up 19.3 % f the requests. A majrity f lans are scheduled fr repayment in 5 years r less (74.4 %), while 41.6 % are paid ff in 1 t 2 years and 32.8 % between 2 and 5 years. Lan payments are predminantly set fr mnthly terms (82.9%). Fixed interest rates dminate in 58.6 % f the lans btained with 34.8% reprting variable rates. Nearly 7% were unaware f the rate they pay. The majrity f the lans reprted are at an interest rate belw 12%, hwever, a few brrwers reprted rates in excess f 12%, high in light f interest rates f the past 3 years, but must be cnsidered with regards t the lending surce and individual credit recrd. Over ne-third reprted they als incurred additinal fees. Over 10% reprt n knwledge f fees. Almst ne-third f the lan recipients, were unaware that lan fees increase the true cst f brrwing.

27 Infrmatin Surces Brrwers find marketing infrmatin easy t read (44%) but did nt receive any in 30.5% f the cases. Disclsures were fund t be understandable fr a majrity f lan recipients. Fr bth marketing infrmatin (10.6%) and disclsures (14.4%), sme respndents did nt find the material easy t understand.

28 Overall Satisfactin $ Three-quarters f the respndents were either very satisfied (40.2%) r satisfied (36.6%) with the credit they btained. $ 5% were dissatisfied r very dissatisfied, and apprximately ne-fifth were neutral abut their satisfactin level.

29 Financial Services! Tw-thirds f small businesses have nt relied n accunting firms in develping lan applicatins in the last three years under cnsideratin.! Legal firms recrd the secnd level f usage fllwed by less than ten percent use amng ther ptins.! Small businesses als rely n a hst f financial services, many f which require the persnal financial statement f the business wner.! A business checking accunt is the mst utilized service (93.3%), fllwed by persnal credit cards (68%), and persnal checking accunts (52.8%).! The latter tw uses further the cncept that the small business wner rutinely c-mingles persnal and business funds, als supprted by ver ne-quarter reprting persnal lans being emplyed.! The use f new financial services technlgies indicates: The mst cmmn use is fr autmatic funds transfers (36.5%) and autmatic payment services (24.1%).

30 Barriers t Obtaining Financing Respndents were asked t rank issues and barriers. Rigrus lending requirements were assessed as the greatest barrier t brrwing, fllwed by the cst f btaining financing, and the feeling that nly cnventinal and SBA lans are available versus alternative financing ptins. Issues relating t financial literacy, namely, lack f infrmatin and lack f knwledge abut lans are als perceived as barriers amng small businesses. Questins als addressed a number f issues that small businesses must face. Incme and prperty taxes were perceived as significant issues by respndents. Gvernment regulatins and tw labr issues -- the quality and csts f labr were als seen as issues amng small businesses. Declining sales and cmpetitin frm larger firms als draw attentin businesses. Inflatin and interest rates are lwer in salience relative t ther issues. In respnse t these barriers and issues, a series f strategies were prpsed. Access t mre infrmatin btained the highest respnse. In general, supprt fr all strategies except access t mre infrmatin is lw.

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32 SOURCES OF VARIATION Gegraphic Area Minrity wnership issues are prminent in the brder regin; Sle prprietrships are mre likely utside majr urban areas f east Texas; Tw-thirds f all lans are applied fr in urban areas; Urban respndents are mre likely t be new custmers while brder and nn-urban/nn-brder businesses have histries f lnger relatinships with banks; Lines f credit requests are higher in urban areas, as is use f credit unins and multi-state institutins; Persnal meetings with lenders are mre likely in the brder ver ther regins and nn-urban/nnbrder ver urban; The number f institutins cntacted is higher in the brder and nn-urban/nn-brder regins; Nn-urban/nn-brder applicants are mre t prvide cllateral, while the brder requires additinal prtectin at a higher rate; Interest rates paid appear higher in the brder regin and lwer in the majr urban areas; Supplemental fees are added t lans mre ften in the brder; C-mingling f a firm s finances with persnal banking is higher utside the urban areas.

33 SOURCES OF VARIATION Industry Classificatin Small firms were mre likely t be sle prprietrships in the retail r service sectrs; Grss revenue was likely t be lwest in retail and service sectr; Minrity wnership is slightly higher in retail and service sectr; Number f emplyees per firm were lwest amng retail and service firms; One individual/majrity cntrl is mre dminant amng retail and service businesses; The recent lan is likely t be under $100,000 and the retail and service classificatin; Gender wnership shws wmen are mre likely t be in retail and service businesses; Sphisticatin f accunting systems suggest the weakest systems are in retail and service businesses; Applicatins fr credit are mre likely t be amng the retail and service classificatin; In the retail and service, c-mingling f funds between the business and wner is higher; Delinquency n a credit agreement is mre prne t ccur in retail and service; Additinal prtectin is mre likely fr a lan applicant frm retail and service businesses; Fixed rate lans clearly dminate regardless f industry classificatin; Amunt f liabilities are lwest in retail and service sectr.

34 $ Minrity-wned firms are nt required t prvide additinal credit enhancements at a higher rate than nn-minrity small businesses. SOURCES OF VARIATION Minrity-Owned Businesses $ Minrity-wned firms generate lwer grss revenue; $ Minrity-wned small businesses appear t be newer; $ Wmen-wned minrity firms are mre prevalent; $ Accunting systems fr minrity-wned firms are less sphisticated than fr nn- minrity firms, but at rates lwer than reprted in earlier studies; $ Applicatins fr credit ccur at a higher rate amng minrity-wned firms; $ Minrity-wned firms take greater advantage f guaranteed lan prgrams; $ The credit evaluatin prcess is lnger fr minrity applicatins; $ Minrity firms questin the fairness f the lan evaluatin prcess at a much higher rate than d nn-minrity firms, $ The evaluatin prcess appears t be the same; $ Minrity-wned firms are denied credit at a higher rate; $ Minrity-wned firms are mre likely t pay higher interest rates; $ Credit discrepancies are mre frequent with minrity firms;

35 SOURCES OF VARIATION Wmen-Owned Businesses $Wmen-wned firms are likely t be newer businesses; $ $Wmen-wned firms are smaller in terms f grss revenues but nt in number f emplyees; $Wmen-wned firms are likely t be structured as sle prprietrships; $Wmen-wned firms are mre likely t utilize a less sphisticated accunting system; $Wmen-wned businesses reprt having fewer utstanding liabilities; $Wmen-wned businesses als brrw smaller amunts, n average; $Wmen-wned firms apply fr gvernment-guaranteed lans at a higher rate than the remainder f the small business cmmunity; $Wmen-wned businesses are n mre likely t be required t prvide additinal written agreements as part f lending requirement; $Wmen-wners, hwever, reprt n substantial differences in the terms r requirements f credit.

36 Assessing Small Business Lending Using Multiple Criteria Scale f Multiple Lan Criteria Best Cnditins Wrst Cnditins Mnthly Accunting------Quarterly Accunting Year-End Financial Year- End Statement and Taxes Taxes Only N Delinquencies Delinquencies Present Custmer with Present Custmer New Custmer Previus Credit Relatinship N Credit Relatinship N Credit Relatinship! 25 percent wuld appear t have the wrst set f cnditins cnfrnting them.! Apprximately ne-third wuld cnceivably be in the best psitin.! Apprximately ne-sixth reprt the wrst case, but did btain financing.! Thse wh had the highest scres were funded except in less than 2% f the cases.! Even with a mixed recrd acrss the 3 cnditins, funding is likely t ccur 6 ut f 7 times.! The findings suggest that ptential brrwers have a chance f btaining funding and can vercme bstacles related t their past experiences and practices.

37 MULTIVARIATE ANALYSIS Binary Lgistic Regressin (BLR) was used t estimate a ttal f 17 equatins evaluating the variables f the study in a statewide cntext and prvide a macr level assessment f interactin f a variety f variables cnsidered by the survey. Key findings were as fllws:! 3 financial predictrs play a significant rle in determining the prbability f lan applicatin apprval : 1. previus relatinship with lender; 2. delinquency recrd; and, 3. accunting system! Minrity wnership at a statewide level des nt impact the lan apprval.! Gender f a firm s wner has n significance upn lan apprval/denial rates.! The nature f a firm s industrial classificatin has n significant effect upn apprval r denial dds.! Legal frm f the firm plays n rle in determining lan apprval rates.! Age f the firm is nt a significant predictr f lan apprval r denial rates.! Larger firms gain an advantage with respect t credit btainment based n revenues.! There is evidence that brder-based firms are faced with lwer lan apprval rates after allwing fr the rle f financial variables and firm size.

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