How Our Changing Economy Is Shaping Money

by Don Rodriguez

Changing-EconomySmall business is getting its shot at securing loans once again. But in a new regulatory environment, banks are more cautious about getting left holding the bag with bad loans that could come back to haunt them. Even credit unions are facing potential changes in laws that could affect their ways of operating as nonprofits. This makes it more challenging for businesses to get the cash they need. So lenders and borrowers need to be willing to try new ways to forge the relationship both want.

Rules of the Game Change in Bank Borrowing

As the economy unraveled during the recession, one sector constantly was in the headlines: banking. The traditional lender to business received scrutiny all the way to Capitol Hill where lawmakers passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. “It changed banking in a number of different ways” with new rules and regulations, says T. Anthony Hammond, a commercial banker for Johnson Bank. Besides defining what banks can and can’t do, there is the related expense of technology that allows government agencies to access the data proving banks don’t revert to old habits. “Bigger banks have more to comply with [because of their size], so costs are higher. But they have resources to comply,” Hammond says. The good news he points to is, Dodd-Frank established capital ratios for banks, so there are not a lot that are overleveraged.

For smaller banks like Hammond’s, the expense of compliance is felt more. For example, a bank could face the dilemma of paying the salary of a loan officer who generates business for the bank or a compliance officer who ensures mandates are met, says Paul Hickman, president and CEO of the Arizona Bankers Association. The need to comply is, he says, a “reaction — and overreaction — to the economic crisis,” since financial service issues were at the heart of the economic crisis. Hammond says that, while following the new guidelines hasn’t changed the way he does business, they can “affect the overall profitability of the bank.”

Because some banks were forced to shut their doors when their liabilities soared as the recession took hold, “what we’ve seen is the industry’s contraction,” Hickman says, noting the number of U.S. banks fell from 12,000 when the recession began to its current level of about 7,000 and the trend could continue until there are only 5,000 in just two years. “Is that good for a large, dynamic economy?” he asks.

While banks don’t typically loan money to start businesses, they indirectly help launch them when homeowners tap into home equity to become entrepreneurs. With lower home values and revised guidelines to determine if mortgage applicants qualify, even equity credit is no longer a sure thing. Traditionally, community bankers could make lending decisions based on qualities observed in applicants, not in paperwork. “Underwriting of a mortgage is an art and a science,” Hickman says. Under stricter guidelines, some “mortgages don’t look like qualified mortgages” to the government, he says.

Even Arizona bankers were interested in tightening up statutes affecting their own industry as Dodd-Frank began to take hold. Passing in their respective legislative chambers during the last session were one bill that would have conformed state law to the Act in use of various risk management tools by commercial banks and another that would have modernized the Uniform Commercial Code to better identify debtors in secured transactions, Hickman says. They were stopped cold along with other pending measures, victims of partisanship retaliations after a battle over the 2014 budget and Medicaid expansion broke out in the Legislature. “We are hopeful that we can work with the governor’s office and legislative leadership in the coming session to get these important bills past the finish line,” he says.

As the recession continued and politicians acted like, well, politicians, existing businesses held back on seeking loans while banks’ assets climbed. Now, banks are witnessing loan growth and there’s room for more. “We’re not at the pace that we want it to be,” Hickman says. “We are looking for opportunities to lend. But we want to do it in a responsible way.”

“Competition for good deals [to lend to] is back to what it was in 2007,” says Ed Zito, president of locally owned and headquartered Alliance Bank of Arizona, noting banks “are back in the business of lending” and are trying to restart their revenue lines. In that competition, however, he has found that while technological enhancements, products and services are important, responsiveness and even proactive attention to customers’ needs is more so.

Hammond observes, “We’re well beyond the point of the ‘sky is falling’ attitude.” He sees customers adding onto buildings and investing in equipment. Banks will be conservative compared to before, but for well-capitalized companies with a good management team, “banks are willing to partner up,” Hammond says.

Washington Federal is one of the newer partners. Starting as a savings and loan charter in 1917, it used deposits to make residential loans. But a shift started seven years ago when it acquired an institution involved in business banking, explains John Medina, senior vice president and division manager of business banking for Washington Federal. With 24 branches in Arizona plus locations in other states, Washington Federal is “engaged more in business lending than before,” he says. To match this portfolio realignment, the bank this year was granted a change to a national bank charter by the Office of the Comptroller of the Currency, a move unrelated to Dodd-Frank. With business accounting for 25 percent of its assets, it is “looking to grow significantly” in that sector, Medina says.

New Tax Talk Could Impact Credit Union Deals

While not as far reaching as Dodd-Frank, possible congressional action could deal a blow to another business-lending sector: credit unions. As part of consideration for widespread tax reform, Congress is considering having the nonprofit institutions pay new taxes. If so, the Credit Union National Association estimates that for every $1 in new credit union taxes, the government wipes out $10 in financial benefits to credit union members, including those who own businesses.

With added expense to credit unions’ business model, it’s inevitable new income would need to be generated through fees or interest rates, says Lori Gallegos, executive vice president and COO of First Credit Union. “A tax on credit unions is a tax on our account holders,” she says.

Like community banks, credit unions are locally owned and operated. “We’re cooperative, not corporate,” Gallegos says. That means all account decisions, including lending, are made locally. “That’s good for small business,” she says. “Being local benefits us, too, because we know our members and it helps us make better lending decisions.”

The average credit union business loan is $258,870 in Arizona, meaning credit unions’ business loans generally go to the smaller businesses. When a credit union lends to business-owning members, the capital can be used to keep them competitive and hire additional employees — up to 2,119 in Arizona.

Gallegos says it’s difficult now to predict whether new taxation by Congress and charging more for business loans could set some members up for defaults, since many factors contribute to such scenarios. “But if the cost of borrowing money increases to offset the tax expense, it may impact the ability to repay a higher rate loan,” she says.

Businesses Turn to Support for Loan Help

When times get tough, it’s not unusual for businesses to turn to support. Locally, that can be found in such groups as the Arizona Small Business Association and the Spirit of Enterprise Center at Arizona State University’s W. P. Carey School of Business. “We’ve seen how the economy has been challenging for everyone,” says ASBA CEO Rick Murray, observing that credit markets have tightened in the past three to four years due to regulation. As a result, people who have taken the plunge to launch a small business of no more than 10 employees are pursuing private funding options such as 401(k) accounts. However, in the last six months, Murray is seeing more banks stepping up to loan to established businesses. “They’ve taken a harder look at requests for loans,” he says.

Most ASBA members are seeking loans that banks are doing with the Small Business Association. Because banks have to keep more capital on hand under Dodd-Frank, they have to have partner with SBA to stay competitive. But such loans have become “burdensome” for borrowers because now they’re going through two lending organizations, Murray says. That means more paperwork and more time waiting for approval.

Gary Naumann, director of the Spirit of Enterprise Center, finds not everyone is prepared to apply. He encourages potential applicants to ask themselves five questions first:

How much do you need?
What are you going to do with it? (“General working capital” isn’t the right answer, Naumann offers.)
Over what time frame is the loan needed?
Who is my funding source?
What’s it going to cost me, including rate and terms of the loan?

After going through this checklist, applicants also need a reality check. “Small business loans, themselves, tend to be less profitable for banks,” says Chris Myers. Bankers tell him it takes as much effort to process a $200,000 loan as it does a $2 million loan, so, naturally, bankers gravitate toward larger accounts.

Myers offers a solution to help a business stand out in the crowd. He is CEO and co-founder of BodeTree Direct, a Web-based solution “designed to bring financial and strategic insight to small business” by providing subscribers with tools that crunch the numbers to provide a better understanding of their companies, he says.

Starting in November, ASBA members will have the option to subscribe to BodeTree | FI. The distinction of the newer product is it will “provide deeper insight and, more important, find capital,” Myers says. It will develop the business analysis that bankers require, then help the user complete 90 percent of the underwriting process. Testing of the new product with small businesses has revealed BodeTree | FI has been able compress what is typically a three-month process into a matter of weeks. The result will be a “one-to-one” offer between applicant and lender. “With efficiencies the product offers, it opens up more access to affordable capital,” Myers says. While no subscription price has been set, he says it will be less than the $49.95 per month for BodeTree Direct.

There are alternatives to these traditional loans. One that Naumann cites is factoring, which was used by early entrepreneurs. A lender buys the accounts receivables for a short period and takes a discount as a method of payment. While there are many businesses willing to do this to raise money fast, he cautions that it is for those who thoroughly understand how it works. Don’t like owing anyone anything? Naumann understands. In fact, in the past he has been one of those entrepreneurs who opted to pull equity from his home. “But it’s something to consider carefully,” he warns. “It takes a couple shots of courage.”

Tech Entrepreneurs Have Their Own ‘Angels’

For some technology companies — which is where a lot of available money is focused — the saviors for providing capital to grow are angel investors. They don’t provide “seed” capital to launch, so those budding entrepreneurs need to look to themselves or families to get needed money for their ideas. Instead, members of the Arizona Technology Investor Forum back companies with working prototypes, says Managing Director Jim Goulka. As the economy has improved, the group is seeing fewer candidates than a year ago along with “fewer desperation business plans,” he says, “but we’re seeing better-quality candidates.”

A smaller candidate pool does not mean interest in angels has dropped. Goulka estimates he talks with 300 companies annually, with 100 to 150 going through the formal application process. A nine-member screening committee then decides which three will be invited to present to group members quarterly. “What we’re looking for is explosive growth,” he says.

The amount of capital granted depends on the members and what they want to commit, since they use their own money, Goulka says. For example, if a company needs $1 million, there may be enough interest among the Arizona Technology Investor Forum members to grant the request. If members want to commit only half, the other half could come from other groups, like the Desert Angels in Tucson.

Interest in new ventures is very much alive. In Arizona, there have been several attempts to create some type of funds to invest in companies, Goulka says. One was HB2646, which was introduced in the state legislature to create a $50-million early-stage venture capital fund using tax credits for insurance companies to offset premium taxes paid by insurers. After passing in the House Commerce Committee, the bill was endorsed in the full House on a 44-15 vote. After its approval by the Senate Finance Committee, however the measure’s momentum stopped. There was no floor vote in the Senate as it was sidetracked, one of the casualties of the standoff over the budget and Medicaid.

Meanwhile, Arizona Technology Investor Forum continues its work to support new ideas. When Goulka assumed his position two-and-a-half years ago, there were 18 members. Now, the total is 70 — and growing. “The growth of the economy is going to create more opportunities to invest,” he says. “And if it’s high quality, we will invest.”

There’s a growing field of those who can make that commitment.

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