Small Banks And Small Businesses: Are They In The Same Condition?

by: John M. Mason

Recently I wrote, "Smaller Banks Are Going Nowhere. The basic premise of this piece was that many of the smaller banks in the United States, particularly those that have assets of less than $1.0 billion, are still suffering from several problems.

First, the balance sheets of these financial institutions still contain assets that are of uncertain value. Second, new rules and regulations are placing substantial burdens and costs on these smaller banks that they have not been able to absorb yet. Third, economic growth remains tepid in the United States but particularly in the markets of many of these "smaller" banks. Fourth, low interest rates have squeezed margins sufficiently so that keeping liquid assets at the Fed (excess reserves) is as profitable as anything that they do. Fifth, there is just so much uncertainty in many of the communities of these "community" banks that it is safer for the bankers to "sit" and hope that time will heal their balance sheets because they are not very confident that "new" loans will solve their problems.

Now, there is growing evidence that small businesses are also facing problems that keep them "on the fence", unable or unwilling to expand their activity. For more on this see "Small Businesses Still Struggle, and That's Impeding Recovery."

Catherine Rampell, the author of this New York Times article, writes, "In survey after survey, owners of small businesses report unbridled pessimism about the economy." Rampell continues, "The small business optimism index from the National Federation of Independent Business-a major industry group for small businesses-is stuck at recessionary level. In January's report, released this week, expectations for business conditions six months from now were at their fourth-lowest reading in nearly 40 years." And this is after the economy has been expanding since July 2009!

Like the smaller banks, many of these smaller companies still have a lot of debt on their balance sheets, or, have experienced some credit difficulties since the financial crisis began in 2007. Furthermore, a lot of small business owners use the value of their homes as collateral to borrow money for business purposes. In many cases home value prices are still sufficiently depressed so as to hamper bank lending.

Remember, many of the "smaller" banks have sufficient impaired debt on their balance sheets so they don't want to make any more loans that in any way can draw the attention of examiners and in so doing raise questions about the viability of the bank or its management.

Rampell quotes Summit Kumar, president of Summit Telecom, a telecommunications company in Hicksville, New York, "The banks are not lending. They claim that they are, but they're not."

Then Mr. Kumar relates his story: "I got a line of credit from a bank five years ago and I paid it back." Sounds good, doesn't it? Mr. Kumar goes on: "Now the same says I'm 'high-risk' business and turns me away."

Rampell then adds the zinger: Mr. Kumar "acknowledges that his business has taken a hit in recent years and that he has had to lay off employees, but he says that his inability to get credit is part of the problem. He says he has had to resort to cash advance companies that expect him to pay back loans at exorbitant interest rates."

But, can the loan officer of a "small" commercial bank, or, the loan committee of a "small" commercial bank, approve such a loan in the current regulatory environment? Remember the loan officer or the loan committee has a bank regulator or a bunch of bank regulators looking over their shoulder on every loan application they review.

Furthermore, small business got "stung" in earlier phases of the recovery. Remember, Mr. Bernanke was seeing "green shoots" several years ago. Rampell cites the "Recovery Summer" of 2010. And, so on.

With economic growth running around 1.5 percent, year-over-year, this is no environment to get excited about.

And, there is the uncertainty created by the federal government, itself. Some of the uncertainty is connected with understanding the real impact of the new health care law. Others uncertainties are connected with the fiscal situation in Washington … potential tax increases and spending cuts. Now, there is the uncertainty related to an increase in the minimum wage.

Ian Shepherdson, chief economists at Pantheon Macroeconomic Advisors is quoted by Rampell as saying, "Politicians are uniformly quick to offer paeans to small businesses, but their actions have directly held back the sector" We, and the press, tend to concentrate so much on what the big banks are doing and what the large corporations are doing that we often fail to perceive what is going on at the more local or regional level.

Right now there still seems to be a lot of struggling going on at this level in the "small" banks and in the "small" businesses. And, these two are so closely tied together that their difficulties play off of one another. And, it seems that until these sectors of the economy come together, economic growth will remain modest and unemployment, or underemployment, will remain excessively high.

Rampell, at the end of her article, discusses the problem of under-employment. Many "smaller" businesses, especially in the service sector, hire a lot of middle-age women. According to the National Federation of Independent Businesses and the Labor Department, however, during the last five years or so a very large number of middle-age women have dropped out of the labor market because these "small" businesses are just not hiring. And, because these individuals have dropped out of the labor market, their "unemployment" is not even measured in the unemployment rate.

The money that is circulating around the economy is going into the biggest banks, the non-bank banks (Remember Mr. Kumar is quoted above as saying that the only places he can borrow from are cash advance companies or "alternative" lenders), and the "big" institutions. As such, there may be lots and lots of money floating around, it is just not available to "smaller" institutions or the "real" economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.