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Community banks show edge over big banks in small-business lending

As community banks go, so do small-business loans.

One of several research papers presented at a recent banking conference showed that community institutions are more active in small-business lending and can grow those loans by picking up the slack of larger banks.

Small-business lending has yet to recover to pre-financial crisis levels, in part because larger banks have focused on lending to larger customers, according to Rebel Cole, a finance professor at Florida Atlantic University. Cole presented his findings at the Community Banking in the 21st Century Research and Policy Conference on Oct. 3.

Across the industry, small-business lending has grown an average of 2% per year, while total business loans have grown 4% per year. Small-business loan originations are down 40% from pre-crisis levels, a decline that is even more pronounced at large banks. But small-business loans have grown faster at community banks compared to large banks, in part because large banks have "disproportionately" favored large-business lending following the financial crisis, Cole wrote.

Janet Garufis, chairman and CEO of community bank Montecito Bancorp, said during the research presentation that some of the drop in small-business lending could be explained by a lack of demand. Small businesses have been reluctant to borrow in the years since the financial crisis, she said, as business owners were concerned about taking on the risk of expansion and about uncertainty in new rules such as the Affordable Care Act.

"It wasn't that there wasn't suitable financing or there wasn't credit available," she said. "We were dying to make loans to anyone who wanted one because we needed to."

Current small-business lending competition remains concentrated among small banks, according to a majority of respondents to the 2018 National Survey of Community Banks. More than half reported that their top competitors were other banks with less than $1 billion in assets, with fewer than 10% of respondents citing competition from banks with more than $10 billion in assets.

Community banks appear to face more competition from other local banks than from the appearance of a remote lender such as Live Oak Bancshares Inc., according to another research paper. Nathaniel Pattison, an assistant professor of economics at Southern Methodist University, looked at the competitive impact of Live Oak on Small Business Administration lending in the specific industries the bank targets. His preliminary paper found "little to no" resulting decline of SBA loans from existing lenders following Live Oak's entrance into these industries.

Another opportunity for community banks to grow small-business lending comes from the way mergers disrupt local markets. Julapa Jagtiani, a researcher at the Federal Reserve Bank of Philadelphia, found that small-business lending "actually did not occur" in the communities where a bank merger target was located. Instead, her research found a "significant increase" in small-business lending in the acquiring bank's counties and a corresponding decline in lending in the target's counties, compared to lending levels before the merger announcement.

"Funding available to small businesses seems to be directed away from the target's community, especially if the acquirers did not also have operations in the same county before the merger," Jagtiani wrote in her working paper. The result is more pronounced when the acquirer is a large bank, she found.

Jagtiani's research suggests that a merger has potentially negative impacts for the target's community, complicating the stated desire of many bank acquirers to enter and lend in new markets. More than 65% of the national survey's respondents said entering a new market was either an "important" or "very important" acquisition motivator.

One reason why small-business lending declines in a merger target's market could be that deals are disruptive to the banks themselves, Montecito’s Garufis responded. She said employees who work for an acquired bank may be distracted by learning and acclimating to the new culture, systems and processes of the buyer and may not be familiar with new loan products.

"These are some really basic process issues that cause people not to be able to do their job," she said. "It's not because they don't want to, it's because they don't know how to."