Goldilocks and Small Business Credit

Scott Shane, Professor of Entrepreneurial Studies at Case Western Reserve University published a recent commentary on Bloomberg Businessweek that will likely echo thoughts of many lenders, borrowers and advisors.  Professor Shane likens the Federal Reserve’s efforts to manage small business credit to the story of Goldilocks and the Three Bears.  Bernanke and his Fed team, supplanting Goldilocks, are “tasting” the small business credit climate and struggling to find a lending environment that’s “just right.”  In Shane’s words,

 

Small business credit can be too hot, with lenders providing too much financing, or it can be too cold, with too little available. The Fed’s job is to get the amount of credit just right, ensuring that the banks provide creditworthy businesses with the capital they need while denying it to those that are too weak to handle the debt.

 

The Fed believes that small business lending was too hot before the financial crisis and many small business believe that small business lending is currently too cold. As evidence, the National Federation of Independent Business noted in a recent lending survey that “more small employers were shut out of the credit market [in 2011] than in prior years.”

 

While I haven’t found evidence of admission from Bernanke and crew that small business lending has been cooled too far, Shane presents a convincing tally of datasets that evidence the pendulum swing from hot to cold:

  • FDIC figures reveal a 39 percent decline in the number of loans under $1 million to businesses (a proxy for small business loans) since June 2007.
  • FDIC figures confirm that the current level is the lowest since 1999, when the U.S. had almost 1 million fewer small businesses than today.
  • FDIC figures show that the real dollar value of commercial loans under $1 million actually decreased 17 percent from 2009 to 2011, while the number of loans declined 8 percent.
  • In the Wells Fargo Small Business Survey, small business owners report that credit was hard to get during the previous 12 months and will be hard to get over the next 12 months as made that claim at the end of the recession.
  • A recent National Federation of Independent Business study indicates that only half of respondents received some or most of the credit they needed in both 2011 and 2009.

 

I subscribe to a philosophy of lean-growth by which young companies stand a better chance of success by remaining hungry for capital. As a mezzanine/subordinated debt provider, I’ve seen my share of companies that were denied senior credit – and for good reason.  In contrast, as a transaction intermediary, I’ve seen my share of companies that were extended senior credit – for no good reason during their infancy – that grew into strong companies with real transferable value.

 

While the credit losses from a “hot” lending environment are readily identifiable and quantifiable; the economic losses from a “cold” lending environment are often less tangible.  As the lending pendulum hangs in the cold position, I wonder what sort of impact this will have in 3, 5, or 10 years’ time?  Will we have a void of growing lower-middle market companies due to a lack of funding from 2008-2012?

 

Only time will tell…