Banks are enjoying improved profits—the best, in fact, since the Great Recession of 2008. But for many a small business owner with a healthy P&L statement and an ambitious agenda, getting a bank to stamp “Approved” on a loan application can seem almost as tough as ever.
Why the reluctance to lend? For starters, banks have to comply with a number of federal regulations introduced since the Great Recession to avoid another meltdown. Those regulations can cause lending officers to sharpen their pencils when analyzing the financials of loan applicants.
A number of other factors are cited by Bill McDermott, CEO of Atlanta-based McDermott Financial Solutions (mcdfs.com). “Many banks have less money to loan because they need to maintain elevated cash reserves to comply with the Dodd–Frank Wall Street Reform and Consumer Protection Act,” he says. Any cash that needs to be stockpiled for federal review can’t be lent to small businesses.
McDermott cites another reason for bank officers to sit on their hands. “Banks make less profit on their loans than in the days prior to the Great Recession because of the current low interest rate environment,” he says. Banks typically loan money to business customers at the rate of two and a half percentage points above prime, which is the rate charged a bank’s most credit-worthy large corporations. And the prime rate, hovering recently at around 3-¼ percent, remains close to an all-time low.
Today a bank with a cost of money of one quarter percent (the rate paid for many money market funds) will typically loan money in the 5-1/4 to 6-1/4 percent interest rate range, giving the bank a five to six percent gross margin. “A bank that is loaning money at 5-1/4 percent is only making half the money it could make if the prime were five points higher,” says McDermott.
Interest rate stability is still another depressant on lending activity, says McDermott. An economic environment with rising interest rates would be more favorable for banks, because they would not have to raise the rates they paid depositors as quickly as they could hike interest rates for new loans. The “spread” between the two interest rates amounts to additional profit for the bank. Absent such opportunity to make money from the spread, banks feel less incentive to make loans.
While banks see diminished opportunity for profitable lending they are also incurring expenses in two areas. The first is investment in technology for the support of mobile banking. The second is compliance with federal regulations related to legislation such as Dodd-Frank, the Patriot Act, and the Bank Secrecy Act. Given their need to make a certain level of profit to pay for all those expenses, many banks are prone to lend money only at rates less than attractive to the typical small business owner.
It all adds up to a challenging lending environment despite the favorable factors of higher bank profitability and a recovering economy. The right bank will be eager to lend, but that doesn’t mean every business will qualify. “Banks will fall over each other for a good company,” says John McQuaig, managing partner of McQuaig & Welk, the Wenatchee, Wash., based management consulting firm (mcqw.com). “But they still can’t afford to take much risk so poor quality deals will remain hard to place.”