[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
WHERE ARE WE NOW? EXAMINING THE POST-RECESSION
SMALL BUSINESS LENDING ENVIRONMENT
=======================================================================
HEARING
before the
SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS
OF THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
DECEMBER 5, 2013
__________
[GRAPHIC] [TIFF OMITTED]
Small Business Committee Document Number 113-047
Available via the GPO Website: www.fdsys.gov
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HOUSE COMMITTEE ON SMALL BUSINESS
SAM GRAVES, Missouri, Chairman
STEVE CHABOT, Ohio
STEVE KING, Iowa
MIKE COFFMAN, Colorado
BLAINE LUETKEMER, Missouri
MICK MULVANEY, South Carolina
SCOTT TIPTON, Colorado
JAIME HERRERA BEUTLER, Washington
RICHARD HANNA, New York
TIM HUELSKAMP, Kansas
DAVID SCHWEIKERT, Arizona
KERRY BENTIVOLIO, Michigan
CHRIS COLLINS, New York
TOM RICE, South Carolina
NYDIA VELAZQUEZ, New York, Ranking Member
KURT SCHRADER, Oregon
YVETTE CLARKE, New York
JUDY CHU, California
JANICE HAHN, California
DONALD PAYNE, JR., New Jersey
GRACE MENG, New York
BRAD SCHNEIDER, Illinois
RON BARBER, Arizona
ANN McLANE KUSTER, New Hampshire
PATRICK MURPHY, Florida
Lori Salley, Staff Director
Paul Sass, Deputy Staff Director
Barry Pineles, Chief Counsel
Michael Day, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Tom Rice.................................................... 1
Hon. Judy Chu.................................................... 2
WITNESSES
Ann Marie Wiersch, Policy Analyst, Federal Reserve Bank of
Cleveland, Cleveland, OH....................................... 4
Jeff Stibel, Chairman and CEO, Dun and Bradstreet Credibility
Corp., Malibu, CA.............................................. 6
Renaud Laplanche, CEO, Lending Club, San Francisco, CA........... 7
Fred L. Green, III, President and CEO, S.C. Bankers Association,
Columbia, SC................................................... 9
John Farmakides, President/CEO, Lafayette FCU, Kensington, MD,
testifying on behalf of the National Association of Federal
Credit Unions.................................................. 11
APPENDIX
Prepared Statements:
Ann Marie Wiersch, Policy Analyst, Federal Reserve Bank of
Cleveland, Cleveland, OH................................... 27
Jeff Stibel, Chairman and CEO, Dun and Bradstreet Credibility
Corp., Malibu, CA.......................................... 34
Renaud Laplanche, CEO, Lending Club, San Francisco, CA....... 42
Fred L. Green, III, President and CEO, S.C. Bankers
Association, Columbia, SC.................................. 45
John Farmakides, President/CEO, Lafayette FCU, Kensington,
MD, testifying on behalf of the National Association of
Federal Credit Unions...................................... 55
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
CUNA - Credit Union National Association..................... 67
Lend Academy................................................. 72
WHERE ARE WE NOW? EXAMINING THE POST-RECESSION SMALL BUSINESS LENDING
ENVIRONMENT
----------
THURSDAY, DECEMBER 5, 2013
House of Representatives,
Committee on Small Business,
Subcommittee on Economic Growth, Tax and Capital
Access,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:02 a.m., in
Room 2360, Rayburn House Office Building, Hon. Tom Rice
[chairman of the Subcommittee] presiding.
Present: Representatives Rice, Chabot, Mulvaney,
Schweikert, Chu, and Payne.
Chairman Rice. Good morning. The hearing will come to
order.
Today we will examine the lending environment for small
businesses. Since small businesses create over two-thirds of
new jobs, we must make an effort to ensure capital is available
for their growth. By comparing pre- and post-recession levels
of traditional small business lending, and analyzing the
factors affecting these levels, we can gain a better
understanding of where we stand and narrow our focus on the
policies that will spur economic growth and job creation.
Recent data shows that banks are making more small loans in
the past 2 years. Despite this improvement, loan levels are
still below where they were before the recession. Economists,
bankers, small business owners, and regulators point to
different reasons to explain the postrecession drop in small
business lending. Some suggest it is reduced demand by small
borrowers, while others point to increasing regulatory scrutiny
on banks.
In reality, a confluence of forces has led to lower levels
of lending. For instance, at the same time banks are being
forced by regulators to require more from borrowers in the way
of collateral and personal guarantees, home values, a huge
source of collateral for borrowers, have dropped. And when the
potential borrowers hear that it is hard to obtain bank
financing, many do not seek it, thereby decreasing loan demand.
We are fortunate to have with us a group of leaders within
the small business financing space, from experts that analyze
lending to those that are on the front lines making the loans.
We will also hear from a business that offers a new source of
financing that is becoming part of the lending environment. I
look forward to learning firsthand what today's witnesses see
as the factors shaping the lending landscape.
With that, I would like to thank our distinguished panel of
witnesses for being here today, and I now recognize the ranking
member for her opening statement.
Ms. Chu. Good morning.
Today's hearing will examine the current state of lending
to small businesses. Although in the last 2 years the lending
environment has slightly improved, bank loans to small
businesses remain below prerecession levels. Multiple factors
and economic trends affect small business lending. And today we
are going to receive testimony from experts and industry
leaders on this very, very important matter.
Evidence suggests that our Nation's economy is slowly but
surely on the mend; 7.8 million jobs have been created since
the postcrisis low of 2010. The housing and auto industries,
which were central to the downturn, have rebounded. The Federal
Reserve's monetary policy stance has remained conducive,
providing market liquidity and supporting the resurgent stock
market. The small business sector is also experiencing an
uptick in hiring.
Still, expansion expectations are below the norms seen
during the previous economic downturns. For job growth to
accelerate and to reach the pace that our economy needs, small
businesses must become a bigger part of the equation. In every
previous recession, it has been small, nimble firms that have
led us back to prosperity by growing quickly and adding new
workers.
In order for these firms to play their traditional job-
creating role, a number of factors must be in place. Perhaps
the most important ingredient is the availability of capital.
If, as the saying goes, small businesses are the economy's
backbone, then the flow of capital is the lifeblood. Since the
great recession, the value of small business loans has remained
at less than 80 percent of its pre recession level. The number
of loans issued also dropped from over 25 million before the
recess to just over 21 million in the second quarter this year.
Although challenges remain, there has been progress. The
Thompson Reuters/Pay Net Small Business Lending Index is well
off its low, but remains below its highs. This indicates that
firms are borrowing again, but are hesitant about the future.
Fewer are also falling behind or defaulting on loans,
suggesting they are in better shape to take on additional debt,
and hopefully expand.
Within this context, it is important to remember that
lending through the Small Business Administration is always
critical for entrepreneurs seeking affordable capital. However,
during periods of economic sluggishness, when credit is tight
elsewhere, the SBA's role becomes more important. Last year,
the agency made nearly $18 billion in 7(a) loans and made
available another $5 billion in financing for projects under
the 504 program.
Unfortunately, while this represents a positive trend in
the total dollars lent, the number of businesses receiving SBA
loans has fallen dramatically. Compared to the agency's high-
water mark in 2007 when over 110,000 small businesses received
loans through this program, the total number helped has fallen
by 51 percent, meaning that 56,000 fewer small businesses
received loan assistance this year.
And understanding what this trend means for entrepreneurs
and what is driving it is of great concern to this
Subcommittee. All of this is occurring against a regulatory
backdrop that is changing. Dodd-Frank resulted in a vast array
of new regulations on the financial sector and established
several new government entities. These new powers are necessary
to address the root causes of the financial crisis,
overleverage and deceptive mortgages, to name a few. At the
same time, we must be sure our Nation's small banks and credit
unions that were not the cause of the downturn are exempted.
While regulations implemented under the act will change
many facets of the financial industry, data indicates that the
perceived regulatory burden has had no negative effect on small
business lending. In fact, a consortium of the Nation's most
prolific small business lenders recently announced they made an
additional $17 billion in loans in the past 2 years.
At today's hearing, we will take the pulse of the small
business lending environment and gain insight about how to
expand small businesses' financing options. And as we do so, it
is important to remember that what makes sense for one
entrepreneur might not work for another, and that there is a
broad spectrum of capital options for small firms. Some
businesses' needs can be met with conventional loans, and for
others a debt-based solution may not make sense at all. Equity
investment might make a better fit.
On that note, I would like to thank our witnesses for
taking time to be here. Their views and experiences will be
very valuable to the Subcommittee as we consider how best to
meet small businesses' capital needs.
Thank you, and I yield back.
Chairman Rice. Thank you, Ms. Chu.
Your opening statements will be submitted for the record.
If any Committee members have opening statements, theirs will
be submitted for the record. I would like to take a moment to
explain the timing lights to you. You have lights in front of
you. They will start out as green. When they turn yellow, you
have 1 minute. When they turn red, your time is up. But within
reason, we will give you a certain amount of flexibility to
finish your statements.
Our first witness is Ann Marie Wiersch, policy analyst at
the Federal Reserve Bank of Cleveland. Ms. Wiersch joined the
bank in 1999, and worked in the accounting and financial
management departments prior to her transition to a policy role
in 2009. She has worked on several Federal Reserve System
initiatives, including the projects focused on small business
issues and State and local government finance. Ms. Wiersch
holds an undergraduate degree in business administration from
Bowling Green State University and an MBA from Cleveland State
University.
Ms. Wiersch, we look forward to your testimony.
STATEMENTS OF ANN MARIE WIERSCH, POLICY ANALYST, FEDERAL
RESERVE BANK OF CLEVELAND, CLEVELAND, OH; JEFF STIBEL, CHAIRMAN
AND CEO, DUN AND BRADSTREET CREDIBILITY CORP., MALIBU, CA;
RENAUD LAPLANCHE, CEO, LENDING CLUB, SAN FRANCISCO, CA; FRED L.
GREEN, III, PRESIDENT AND CEO, S.C. BANKERS ASSOCIATION,
COLUMBIA, SC; AND JOHN FARMAKIDES, VICE PRESIDENT OF
LEGISLATIVE AFFAIRS, NATIONAL ASSOCIATION OF FEDERAL CREDIT
UNIONS, ARLINGTON, VA
STATEMENT OF ANN MARIE WIERSCH
Ms. Wiersch. Chairman Rice, Ranking Member Chu, and
distinguished members of the Subcommittee, it is an honor to
testify before you today on the state of small business
lending. My statement will focus on the decline in lending to
small businesses and the factors that are driving that decline.
My remarks represent my own views and are not official views of
the Federal Reserve Bank of Cleveland, or any other element of
the Federal Reserve System.
Recent industry and media reports provide a mix of
perspectives on the state of small business lending.
Contradictory messages abound and often result from
inconsistent definitions of what constitutes a small business
and from the absence of comprehensive and reliable data on
small business lending.
Banks and government agencies use a wide range of
parameters to classify firms as small businesses. One
frequently cited definition is so expansive that it includes
more than 99 percent of businesses in the U.S. It should not
come as a surprise then that we hear so many differing reports
about small business conditions when firms of so many different
sizes and industries are analyzed together. In addition, the
considerable lack of data on small business lending and the
variance in the size of firms and loans included leads to
inconsistency in reporting among the data that are available.
Nonetheless, we do know that bank lending to small
businesses declined since the onset of the great recession.
According to FDIC data, the current value of small loans
outstanding is about 78 percent of its prerecession level in
inflation-adjusted terms. Recent analysis by the Federal
Reserve Bank of Cleveland concludes that there are a number of
factors driving this trend. Fewer small businesses are
interested in borrowing than in past years. And at the same
time, small business financials and collateral values remain
weak, depressing loan approval rates. Furthermore, increased
scrutiny from regulators led some banks to boost their lending
standards, resulting in a smaller fraction of creditworthy
borrowers.
Finally, shifts within the banking industry have reduced
the number of banks focused on the small business sector. Small
business lending has become relatively less profitable than
other types of lending, dampening some bankers' interest in
this market.
Small businesses were hit hard by the economic downturn,
and weak earnings and sales mean that fewer businesses are
looking to expand. Surveys show that since 2007, fewer
businesses plan to seek credit, increase capital investment,
and hire additional workers.
Some of the subdued demand for loans may stem from
perceptions that credit is not readily available. According to
recent surveys, more business owners think that credit has
become harder to get and will remain so.
The supply of credit has also declined as lenders are
approving fewer small business loan applications, with many
firms lacking the cash flow, credit scores, and collateral that
banks require. More lending is secured by collateral now than
before the recession, and the decline in value of both
commercial and residential properties has made it difficult for
businesses to meet collateral requirements.
At the same time, bankers have increased their credit
standards, meaning that fewer small businesses qualify for
loans than before the economic downturn. Banks tightened
lending standards significantly during the recession, and while
standards have eased somewhat in recent quarters, data show
they remain stricter for small businesses than for large firms.
Furthermore, there is evidence that heightened scrutiny by
regulators factored into banks' decisions to tighten standards.
The research shows that elevated levels of supervisory
stringency have a material impact on total loans and loan
capacity.
The decline in lending also reflects longer term trends.
Banks have been exiting the small business loan market for over
a decade, leading to a reduction in the share of small business
loans in banks' portfolios. The FDIC reports that the fraction
of nonfarm, nonresidential loans of less than a million dollars
has declined steadily since 1998, dropping from 51 to 29
percent.
Consolidation of the banking industry has reduced the
number of small banks, which are more likely to lend to small
businesses. Moreover, increased competition in the banking
sector has led some bankers to seek bigger, more profitable
loans. The result has been a decline in small business loans,
which are less profitable, because they are banker time
intensive, are more difficult to automate and securitize, and
have higher costs to underwrite and service.
While the decline in small business credit since the great
recession is evident, the causes of the decline are less clear.
A careful analysis of various data sources suggests that a
multitude of factors explain the reduction in credit. The
supply and demand forces unleashed by the financial crisis
added to longer term trends, as some banks had already been
shifting away from the small business credit market.
The confluence of factors makes it unlikely that small
business credit will spontaneously increase any time soon.
Given the contribution that small businesses make to employment
and economic activity, policymakers may be inclined to
intervene to promote greater access to credit for small
business owners. When considering means of intervention,
however it is important to be cognizant that multiple factors
are affecting credit demand and supply. Any proposed solution
should consider the combined effect of all the factors
involved.
This concludes my prepared remarks, and I look forward to
your questions.
Chairman Rice. Thank you, ma'am.
Our next witness is Jeff Stibel, chairman, chief executive
officer, and president of Dun & Bradstreet Credibility
Corporation. Mr. Stibel was previously president and CEO of
Web.com, Inc., and currently sits on the boards of numerous
private and public companies, as well as academic boards of
Tufts University and Brown University. He is the author of
academic and business articles, the book ``Wired for Thought,''
and is the named inventor of the U.S. patent for search engine
interfaces. Additionally, he was the recipient of the Brain and
Behavior Fellowship while studying for his Ph.D. at Brown
University.
Mr. Stibel, we look forward to your testimony.
STATEMENT OF JEFF STIBEL
Mr. Stibel. Thank you, Chairman Rice, Ranking Member Chu,
the Committee, and its wonderful staff for having me here today
to discuss what I believe is one of the most important topics
in regards to the economy today.
As you mentioned, Chairman Rice, I am the CEO of Dun &
Bradstreet Credibility Corp. We are one of the largest business
credit monitoring companies in the United States. So I believe
I have a unique perspective into the topic of small business
lending. My written testimony is full of statistics that
demonstrate in short that small businesses today are finally
doing well again. Yet despite that fact, they are not adding
jobs.
The reason is because they need access to capital to grow
their businesses, yet they are not able to secure sufficient
loans. It is a small business paradox, one in which small
businesses are growing revenues but not payroll, and that is
hurting our economy and society as a whole. What we are seeing,
in effect, is the smaller the business, the greater the revenue
growth. And we are seeing this throughout this year.
This is a good thing. It also means that the smaller the
business, the greater the productivity as measured in terms of
revenue output per employee. However, what we are not seeing is
that the smaller businesses are adding jobs. And it is the jobs
that really drive our economy forward in the long run.
Rather than regurgitate these statistics, I would like to
tell a story about a small business owner that I met only a few
days ago. I believe his story, better than any statistics, will
encapsulate the problems that we are facing.
I met Mike Banfield on Monday of this week. He founded
SpringStar in 1998 in Seattle, Washington, to offer organic
pest control products. It was a huge success story almost right
from the beginning. He grew revenues, he grew employees. He
eventually got a bank loan, and that fueled his growth even
further. Throughout the recession, Mike's business actually
thrived, and he continued to grow.
However, as we have all seen, banks didn't fare as well. So
the bank ended up calling his loan. Despite the fact that this
was an SBA-backed loan, Mike had to give a personal guarantee
because that is still required. And when he pulled that loan,
Mike's successful business went under, and he almost went
bankrupt himself, ruining his family.
The good news is that Mike is an entrepreneur and he
persevered and he ended up finding an alternative source of
capital, rebuilt his business, was able to grow that business.
And that business is now thriving today, with record revenues.
However, he hasn't added any jobs. To add jobs, he needs
greater access to capital. The problem is that Mike has been
trying for years and can't get a bank loan. Now, he is just
plain discouraged. He needs a loan, but no longer wants a loan.
A little known fact in business is that jobs are added for
future growth, not current demand. For current demand, people
in business just work harder. Job growth is an investment, just
like computers, equipment, tools, manufacturing. Investments
require capital, but many companies like Mike's aren't willing
or able to secure loans anymore. And the stats are, frankly,
alarming. The smallest businesses have less access to capital,
and the smallest business owners have less desire for that
capital.
We have a small business paradox, and there is an even
greater need than there ever has before. This personally is a
painful story to hear as a business person. A company poised
for success that just needs access to capital. I suspect it is
a painful story to hear for government. A company poised to
impact the economy and society, but can't unless it gets access
to capital.
But most of all, this is a painful story to hear for the
unemployed. We have people who desire to contribute to society,
who see a desperate need from a company, but a need and desire
that cannot be fulfilled without access to capital. I believe
that is why we are all here today. And working together,
business, banks, and the government, we can all work to make a
difference. So thank you.
Chairman Rice. Thank you, Mr. Stibel.
Our next witness is Renaud Laplanche, founder and CEO of
Lending Club. Prior to starting Lending Club in 2006 Mr.
Laplanche was the founder and CEO of TripleHop Technologies, an
enterprise software company eventually acquired by Oracle. He
was named the 2013 Ernst & Young entrepreneur of the year award
winner for northern California and 2012 entrepreneur of the
year at the BFM awards. Mr. Laplanche has a master's of
business administration from HEC and London Business School,
and a J.D. from Montpelier University, and is a frequent guest
lecturer at Columbia Business School.
Mr. Laplanche, we look forward to your testimony.
STATEMENT OF RENAUD LAPLANCHE
Mr. Laplanche. Thank you. Good morning. Thank you for
having me. My name is Renaud Laplanche, and I am the founder
and CEO of Lending Club, a credit platform that employs over
300 people in San Francisco and has facilitated over $2 billion
in consumer loans this year, funded by both individual and
institutional investors. And we will be launching a dedicated
small business lending platform in the next quarter.
My father was a small business owner. He owned a grocery
store in a small town in France. And I spent every day of my
teenage years, from 5 to 8 in the morning before class, helping
him in the store.
After having started two companies in New York and San
Francisco, residing in the U.S. for over 14 years, and starting
a family here, I recently passed my citizenship test and will
soon be a U.S. citizen. Testifying before this Committee on the
state of small business lending in America is a very special
moment for me.
Small businesses are not only a driving force in the U.S.
economy, they are an essential part of the American dream. I
believe it is our shared responsibility to ensure that these
businesses and their owners have sufficient access to capital
on fair terms.
I have two points I hope to convey to you today. First,
small businesses have insufficient access to credit, and the
situation is not getting any better. Second, their credit
performance as a group suggests that they should be getting
more credit.
A survey released by the Federal Reserve Bank of New York
in August of this year was the latest to paint a grim picture
of availability of credit to small businesses. Access to
capital was reported as by far the biggest barrier to growth.
Out of every 100 small businesses, 70 wanted financing. Of
those 70, 29 were too discouraged to even apply. Of the 41 that
did apply for credit, only 5 received the amount they wanted.
Substantially, all of these businesses were looking for $1
million or less in capital.
The situation has not gotten any better lately. While the
overall volume of loans of more than a million dollars has
risen slightly since 2008, loans of less than 1 million have
fallen by 19 percent. The number of small businesses with a
business loan fell by 33 percent from 2008 to 2011.
The problem is worse for the smallest businesses. While
businesses with 20-plus employees reported an increase in bank
loans from 2009 to 2011, the majority of small businesses,
which have fewer than 20 employees, reported a decline, with
the smallest businesses suffering the steepest decline.
Businesses with two to four employees reported a 46 percent
reduction in bank loans over that same period.
While traditional sources of capital have pulled back,
alternatives are on the rise. Alternative lenders, such as
online lenders and merchant cash advance providers, are the
fastest growing segment of the SMB loan market, reporting a 64
percent growth in originations over the last 4 years. Many of
these alternative lenders, however, charge fees and rates that
result in annual percentage rates generally in excess of 40
percent. And without always full transparency, business owners
don't always understand the true cost of these loans. This lack
of understanding can be very harmful to small businesses, which
could find themselves in a spiral of inescapable debt service.
Small business credit performance and loan performance,
however, is doing just fine. Charge-off rates on small business
loans have been below 1 percent since March 2012, down from a
peak of nearly 3 percent in 2009. In contrast, charge-off rates
on consumer credit cards peaked above 10 percent in the
financial crisis. These figures show that absolute loan
performance is not the main issue of declining SMB loan
issuance. We believe a larger part of the issue lies in high
underwriting costs and generally high operating costs for the
lenders.
SMBs are a very heterogeneous group, and therefore the
underwriting and processing of these loans is not as cost
efficient as underwriting consumers, a more homogenous group.
Business loan underwriting requires an understanding of the
business plan and financials and interviews with management
that result in higher underwriting costs, which make smaller
loans, under $1 million, and especially under $250,000, less
attractive to lenders. By contrast, larger loans, going mostly
to larger businesses, are more attractive, as they allow for
underwriting costs to be amortized over a larger amount and
longer loan period.
We believe we have solutions to bring underwriting costs
down and create the conditions for credit to become more
available and more affordable to small businesses in America,
and we would be honored to answer the Subcommittee questions in
that regard.
Chairman Rice. Thank you, Mr. Laplanche.
Our next witness is Fred Green, III, president and CEO of
the South Carolina Bankers Association, based in Columbia,
South Carolina. Prior to his current position, Mr. Green served
as president and COO of Sunovis Financial Corp, a five-State
bank holding company, and before this as president, CEO, and
chairman of the National Bank of South Carolina. Mr. Green also
previously served on the board of the Fifth District Federal
Reserve Bank, based in Richmond, Virginia, and on the Federal
Advisory Council for both the Fifth and Sixth Districts. He
received his B.S. and MBA from the University of South
Carolina. Go Gamecocks.
Mr. Green, we look forward to your testimony.
STATEMENT OF FRED L. GREEN, III
Mr. Green. Good morning. Chairman Rice, Ranking Member Chu,
members of the Committee, my name is Fred Green. I am the
president and CEO of the South Carolina Bankers Association. We
are the professional trade association that has represented
South Carolina banks for over 110 years. Our members are both
large and small banks, and collectively they hold about 99
percent of the deposit market share in our State. I have been a
banker for 34 years, mostly in leadership roles in commercial
banks, and for the last 2 years I have headed up our State
association.
This morning I am pleased to share the banking industry's
perspective on the state of the small business lending
environment. You all know how important small business is to
the national economy. Small businesses account for over half
the jobs in the U.S., and as much as 65 percent of new jobs
created over the last 15 years.
Banks are the primary lenders to small businesses, and
their presence in local communities throughout our Nation is
critical to meeting the unique needs of new and developing
companies. There is a symbiotic relationship between the health
of a community and the health of the banks that are located and
operate there. This is why small business lending is an
important part of every bank strategy and why banks today
provide more than 21 million small business loans.
Loan demand has improved since the recession. However, it
remains at relatively weak levels, held back, I think, and we
all think, by uncertainty about the future. Concerns over
changes to taxes, employment costs, and regulation make small
business owners less interested in expanding and incurring new
debt to fund that expansion. Another point that reinforces the
lower demand is the utilization of borrowings under existing
committed lines is at a relatively low level at 50 percent.
These are loans that have already been committed, the borrower
can draw down to expand, but have only drawn up to 50 percent.
Despite the low loan demand, banks continue to meet the
needs of their customers. In every community, banks are
actively lending and continually looking for lending
opportunities. After declines in the loan portfolios since
prerecession peaks, recent FDIC data shows that outstanding
loans have been growing over the last 12 months.
Banks face challenges in providing loans to meet their
customers' needs with the most recent wave of regulations as
well. The cumulative impact of hundreds of new or revised
regulations may be a weight too great for many small banks to
bear. Congress must be vigilant in its oversight in
implementing the Dodd-Frank Act to ensure that rules are
adopted only if they result in a benefit that clearly outweighs
the burden. Some rules under Dodd-Frank, if done improperly,
will literally drive some banks out of business.
In South Carolina, we recognize this growing concern, and
recently held a special conference of our top bank executives
to address significantly stricter mortgage regulations and
capital standards that will be implemented next year. Some
community banks have already told us that they will have to
stop offering certain products, like residential mortgages,
because of the new lending regulations.
For many, these community banks are the only option in
their community, the only source of lending of this type in
their community. In fact, community banks are the only physical
banking presence in one-fifth of the counties in the United
States. And more regulation means more resources devoted to
regulatory compliance, and this means fewer resources can be
dedicated to doing what banks do best, and that is meeting the
credit needs of the local communities, the businesses, and the
residents that are there.
Banks are eager to serve the financing needs of small
businesses. They understand that they play a critical role in
their local economies, and no bank has or wants to stop
pursuing small business lending. Yet small businesses remain
hesitant to expand due to the economic uncertainty. This does
not mean that banks are not making loans. Our economy is
growing, although slowly, and banks are addressing the
financing needs that exist today.
Healthy, properly financed small businesses are absolutely
critical to our communities' economies. Banks understand their
role in this and continue to make loans to every creditworthy
borrower they can, despite an increasingly difficult lending
environment.
Thank you again for the opportunity to testify.
Chairman Rice. Thank you, Mr. Green.
I would now yield to Ms. Chu, who will introduce our final
witness.
Ms. Chu. I have the pleasure of introducing B. John
Farmakides, president and CEO of Lafayette Federal Credit
Union. Mr. Farmakides is the president and CEO of this credit
union. He has been an active member of this particular credit
union community since 1994 and was named president and CEO in
2007. Prior to that, he worked in investment banking,
commercial real estate, and for the Federal Government.
Currently, Mr. Farmakides holds positions on many
professional boards and serves on the regulatory committee of
the National Association of Federal Credit Unions. Mr.
Farmakides received his BBA and MBA degrees from James Madison
University and a law degree from the American University.
Welcome, Mr. Farmakides.
STATEMENT OF JOHN FARMAKIDES
Mr. Farmakides. Thank you. Good morning Chairman Rice,
Ranking Member Chu, and members of the Subcommittee. My name is
John Farmakides, and I am testifying today on behalf of the
National Association of Federal Credit Unions. I serve as
president and CEO of Lafayette Federal Credit Union,
headquartered in Kensington, Maryland.
NAFCU and the entire credit union community appreciate the
opportunity to discuss the small business lending environment.
Credit unions serve over 97 million people from all walks of
life, and we are eager to provide our members the best lending
opportunities, while helping to spur job creation.
Despite regulatory and statutory obstacles to credit union
business lending, a November 2013 survey of NAFCU members found
that credit union member business lending is growing over the
next 12 months. On a scale that goes from negative 100 to
positive 100, where zero indicates flat growth, the median
growth expectation for credit unions was 35.6.
Still, credit unions are hampered in their ability to help
small businesses by an arbitrary and outdated member business
lending cap that hasn't been adjusted in over 15 years. Credit
union member business lending is limited to 12.25 percent of
total assets, with member business loans over $50,000 counting
against the cap. This is counterproductive as the country
continues to recover from the financial crisis.
At Lafayette, we have seen increased demand from our
members to access business lines of credit, to help meet day-
to-day cash flow shortfalls, and manage the needs of their
businesses. I have example after example of ways we have been
able to help, such as a $125,000 line of credit we extended to
a local bike rental and touring company to help manage the
cyclical nature of their business.
Unfortunately, any line of credit above the $50,000
threshold counts towards the cap, even if the funds are not
actually extended. Consequently, Lafayette is forced to pick
and choose which business loans will be funded even though all
are creditworthy. Businesses often turn to us when they have
denied lines of credit from other lenders. So if we can't
extend the line of credit, it is not likely to happen anywhere
else.
I am very proud of my staff and the level of expertise we
have in member business lending. Just in the last year, we have
been able to assist very small traditional companies, such as a
specialty bakery with a single owner. At the same time, we have
made loans to several consulting firms related to government
contracting, in addition to a trucking delivery service, as
well as an innovative solar energy appliance company.
We urge members of the Subcommittee to help credit unions
by supporting corrective legislation to modernize the cap, such
as a bipartisan bill introduced by Representative Ed Royce and
Carolyn McCarthy, H.R. 688, along with the ideas to assist
small businesses, such as adjusting the outdated definition of
a member business loan from $50,000 to a new 21st century
number of $250,000, indexed for inflation.
The Small Business Administration loan programs also are an
important resource that help credit unions provide capital.
However, utilizing an SBA loan guarantee program requires
meeting stringent government regulations. We are an approved
SBA 7(a) lender, but currently have just one SBA 504 loan
outstanding and one USDA business and industry loan
outstanding.
Part of the challenge for credit unions is determining the
overall applicant eligibility to participate in an SBA program,
which is nearly as important as determining the applicant's
creditworthiness. Failing to meet certain eligibility criteria
may preclude the applicant from participating in an SBA
guaranteed loan program. Eligibility criteria includes, among
other things, size restrictions, type of business, use of
proceeds, credit standards, and meeting a credit-elsewhere
test.
If Congress and the SBA were to make it easier for credit
unions to participate in these programs, small businesses
throughout the Nation will have greater access to capital at a
time when it is needed most. A 2011 SBA study found that credit
unions played an important countercyclical role to meet demands
of small business loans while others pulled back during the
recent recession.
In conclusion, small businesses are the driving force of
our economy. Credit unions play an important role in helping
our member small businesses access the funds they need.
Congress should do everything they can to ensure credit unions
can meet the needs of their members. Thank you for the
opportunity to testify today, and I welcome any questions you
may have.
Chairman Rice. Thank you, Mr. Farmakides.
I am going to withhold my questions until the end, and work
with the panel here.
Ms. Chu, would you like to do the same? Whichever order you
prefer is fine with me.
Ms. Chu. Yes. Well, you know what, I would like to defer to
the member as well and give him a first shot.
Chairman Rice. Okay. I am going to start with Mr. Mulvaney
then. Thank you.
Mr. Mulvaney. Thank you, Mr. Chairman.
Folks, thanks very much for participating today. In
listening to your testimony, I harken back to a story that I
heard when I was in Charleston, South Carolina, a couple months
ago, meeting with one of the small community banks there, and
they were telling me about the last visit they had from their
examiner. And the examiner at the end of the process asked them
how they were dealing with Dodd-Frank. And the bank president
said, well, it is absolutely killing us. The additional
paperwork has required us to hire three new people to do
nothing but fill out the new oversight paperwork. And the
examiner's response was, well, then it is working, because you
have created three jobs.
I think we could leave for another day the discussion as to
whether or not that is really jobs created or jobs simply
shifted from one part of the economy to another. But it reminds
me of something that Mr. Green spoke to, which is the impact of
Dodd-Frank on capital available for lending. It strikes me if I
have to hire three people to fill out paperwork, that takes
money away from what I can lend out to my customers and so
forth.
Mr. Green, walk me through just a couple examples you think
of how Dodd-Frank is impacting the capital available for small
business lending.
Mr. Green. Well, Congressman, first off, the example you
gave is what we hear from all of our bankers throughout the
State, and I would think many of our counterparts throughout
the country. There is a shift of resources away from customer
contact, bankers, those that might be out looking for loans and
making loans, now to the compliance side.
The banking industry, bankers by definition are risk
averse. They have to understand the risk, they have to put in
policies and procedures to manage that risk. And with the
mountain of regulations that have come and been thrown on the
banking industry, and not only the volume but the velocity, the
quickness in which it has come in, the proposed regulations
that will soon follow, the banks have had to go out and hire
lawyers, consultants, compliance folks, as you indicated. And
those are resources that had heretofore been out meeting the
needs of the borrowing constituents around in the community.
That is one example.
The other example would be documentation, and that is a big
one, because lending is both an art and a science. When I
started in the banking business, we called it the C's of
credit. The science part of the C's of credit are cash flow,
capacity, collateral, things like that.
The primary part of the C's of credit were characters. In
the larger loan opportunities the quality of the financial
information is much stronger than it is in the smaller
borrowing entities, the smaller companies. The quality of their
financial information is not as robust. They don't have as much
information. They can't predict the future maybe as well based
on trends. So the tipping point between whether many loans are
made in that smaller category falls to character. And that is
knowing the customer, knowing the community, knowing the
competitors, and the ability to maybe take that risk.
Now, under Dodd-Frank and under the regulations, you have
to document every loan opportunity. The problem there is you
can't document the intangibles, like I just described. As a
result, we have had many bankers come to us and say, we would
have made this loan many times in the past, in fact made many
loans like this in the past, and they are good customers today,
but we can't make that loan today because we can't document
this intangible piece that is so important. So as a result,
there are, we think, a lot of loans, primarily in that smaller
category, that aren't being made as a result of the
regulations.
Mr. Mulvaney. I also get the impression that the compliance
requirements are driving some consolidation. There is a great
deal of consolidation in the industry, but some of it is being
driven by compliance requirements because the smaller
institutions simply don't have the infrastructure necessary to
meet the compliance requirements. And it strikes me that is
also limiting availability of capital to small businesses.
Would you agree with that?
Mr. Green. I agree, yes, sir. If you think of it this way,
compliance cost is a fixed cost. The larger the institution,
that cost is spread over a larger asset base and larger
earnings base. The smaller the institution, that is a heavier
burden.
Regulation applies to all banks, regardless of size. So the
smaller the institution, has to dedicate more resources, more
cost, and it has a smaller base to spread it over. So
therefore, their earnings capacity is less. Earnings capacity
is less, the future is maybe uncertain. Consolidation has
occurred and will continue to occur. I have talked to a number
of investment bankers who have told me that there is a
tremendous amount of conversation going on now with smaller
community banks, and a lot has to do with this increased cost
structure as a result.
Mr. Mulvaney. And there was something that Mr. Laplanche
said--I am not going to get a chance to ask questions, maybe we
will get a second round later on--that said that because of the
character, the intangible nature of small businesses, that it
is higher cost to lend to small business, it is harder to do,
and if we don't have these community-based institutions, the
larger institutions simply aren't going to take on that lending
possibility. But I will maybe get a chance to ask that question
later on.
Thank you, Mr. Chairman.
Chairman Rice. Thank you, Mr. Mulvaney.
Mr. Payne.
Mr. Payne. Thank you, Mr. Chairman, and to the ranking
member.
Let's see. Mr. Laplanche, you in your written testimony are
proclaiming to have solutions to bring underwriting costs down
and create conditions to increase credit availability and
affordability. Please share some of those ideas with the
Committee.
Mr. Laplanche. Yes. Thank you for giving me this
opportunity. So, first, I want to start by saying that nothing
will ever get better, no underwriting process would ever get
better than the relationship between a community banker and a
small business owner. That is always going to be the best way
to--combined with financial information and credit data--the
best way to assess a small business owner's ability to repay
the loan and make the business successful.
I think the solutions we are working on are not designed to
be a substitute. They are really designed to fill in a void. So
in the absence of that relationship, or in circumstances where
these relationships do not lead to a successful loan
application, we believe we can offer tools that help make these
loans possible and at a low underwriting cost.
And part of the answer here is technology. And we believe
that technology can be applied in two different ways. One, to
aggregate financial data and make the financial data more
readily available to loan underwriters. And two, by looking
into new, nontraditional underwriting data sources.
So in the first category we are working with a number of
data providers to help pool data about the small businesses
that apply for a loan with the expressed consent of the small
business owner. For example, we are working with Intuit
Corporation, the maker of QuickBooks, to through an API code
for a technology solution, essentially collect all the
QuickBooks data, so the entire accounting of the small
business, and extract that information, run analysis on that
information, calculate ratios how that can be used as part of
the underwriting and can be reviewed by the underwriter.
And that data extraction, the data analysis process can
make the job of the underwriter easier and can also lower the
burden for the business owner to collect the data and transfer
the data to the underwriter. That is one category.
The other category is incorporating in the decision, in the
pricing decision of the underwriting decision, data sources
that are available online now through the Internet and can be
used as a proxy of business reputation and future business
performance. There are rating and customer satisfaction Web
sites like Yelp or OpenTable or Angie's List that give the
opportunity to customers to rank small businesses and give
feedback on the experience they had with the business.
Our ability to collect that data, analyze that data, and
use that data as an additional source for underwriting can be
extremely useful, can be done in a way that is highly
automated, low cost, and provide some insight as a complement
to other more traditional sources, provide some insight into
future business performance.
Mr. Payne. Okay. Thank you.
In the interests of time, I will yield back so we can
possibly get to a second round. Thank you.
Chairman Rice. Mr. Schweikert?
Mr. Schweikert. Thank you, Mr. Chairman.
And forgive me if this one becomes a little ethereal, but
on particularly small, truly small businesses, you know, the
one with under 25 employees that comes into an institution, and
I don't know if this might be from a regulator's standpoint, if
it were a decade ago and I am coming in for working capital, do
you feel, for those of you on the lending side, you had more
flexibility? Okay, you have a couple trucks that you have
equity in. All right, well, we know you own your home. And are
the regulators not allowing you to look at their full asset
bundle, and do you get punished if you have done that look at
the asset bundle when you have your auditing mechanics?
Mr. Green.
Mr. Green. Congressman, let me start with that. I do think
the flexibility has been significantly reduced. I mentioned the
regulatory scrutiny and documentation. You know, a lot of times
the primary asset of a small business owner is their home and
equity in their home. To be able to take that equity now as
collateral requires a whole lot more cost, a whole lot more
scrutiny, a lot more documentation than it would have before.
And the same goes for other type assets. So, yes, sir, it
absolutely has changed.
Mr. Schweikert. On that same look on cosigners for debt, I
don't know how many people in the room at sometime in their
life have had a family member wanted to start a business, and
we were all really, really stupid or very, very loving,
whatever you want to consider it, in helping cosign, you know,
them to get some of their debt instruments to start their
business. And my understanding is that also is one of the
things we will see dramatically less of as being an acceptable
collateral mechanic today. I mean, is what I am being told your
experiences?
Mr. Green. Yes, sir. I will just add one more comment and
let my other panelists talk about it.
That is important, because I mentioned earlier about
character sometimes being the tipping point. A lot of those
guarantors are family members. And having a family member on
there, father, mother, that would guarantee it, a lot of times
they were tougher on that borrower maybe than the lender would
be because of that.
Mr. Schweikert. Well, it just makes Thanksgiving really
uncomfortable when you have problems.
Mr. Green. Yes, sir.
Mr. Schweikert. And forgive me, is it Wyrich?
Ms. Wiersch. Wiersch.
Mr. Schweikert. Wiersch. Now, you actually, with your
position, you actually touch probably a lot of accumulated
data. Are you seeing something in the data that is sort of
outside the folklore we are having this discussion of? You
know, is it those small businesses aren't walking into their
credit unions or their community banks to even ask for a loan?
I mean, what do you see really going on in the data?
Ms. Wiersch. Really, I think it is the combination of
factors. Demand is definitely part of the issue. And, you know,
in terms of some of these, the impact of regulatory scrutiny,
as we are talking about it, it is interesting. If you look at
the data, you see that the--and this is information that we can
get in terms of why banks are tightening their lending
standards. Regulation is less of a concern, in terms of
regulatory policy, regulatory scrutiny, that is the side that
we are looking at it from, it is less of a factor now. The
bigger factors in tightening lending standards would be, you
know, issues like their perception of the economic environment,
their risk appetite, you know, those types of issues. Loan
performance. You know, their market strategy.
Mr. Schweikert. In that area, when I have some of my
regulated entities, you know, my community banks come to me and
say, our discussion about our buckets, I am holding too much
real estate, I need to roll to this, roll to that. So there is
entire silos of what you might have used in that cross-
collateralization that, boom, are gone, that you can't use.
Doesn't that ultimately, that mechanic have the cascade effect
of, don't come talk to us, I have no capacity?
Ms. Wiersch. You know, I would just reiterate that, you
know, lending decisions and the decisions about portfolio
composition are truly--these are bank decisions and bank
management decisions. There is an influence from----
Mr. Schweikert. Are they truly a bank decision? I mean, I
know that you are on the Fed side, not the FDIC side, but that
is in many ways a regulator decision.
Ms. Wiersch. There is some consideration of the information
the regulators give. And I think maybe from the bankers' side
they can provide a little more insight on that. From what we
see in the data, it just shows that regulatory policy is less
of a factor in determining, you know, the lending types of
decisions. Now, in terms of this idea of----
Mr. Schweikert. And I don't mean to cut----
Ms. Wiersch. No, no, that is okay.
Mr. Schweikert. We are over time. But this is actually a
really interesting discussion. At some point I hope we can wrap
to it. Because I am trying to mix what we get anecdotally with
where we find actual data.
So thank you, Mr. Chairman. Sorry for going over time.
Chairman Rice. Thank you, Mr. Schweikert.
Ms. Chu.
Ms. Chu. Thank you, Mr. Chair.
Mr. Farmakides, credit unions have expressed to the
Committee that the barriers to entry to participate in SBA
lending are too great, and that is why very few credit unions
opt to participate. Now, you have a most interesting history
because you worked for the SBA and yet you also represent the
credit unions. So you have seen things from both sides of the
fence. Other than what you have mentioned in your testimony
about permanently exempting SBA loans from counting against the
MBL cap, what else can we do to encourage credit union
participation in SBA lending programs?
Mr. Farmakides. I think there has been bills presented
before us today that basically are looking for ways to allow
credit unions like ours to do more SBA lending. I think the key
for that is changing the way SBA administers its program. The
way that they have done it right now, the rules and the
regulations to follow are very difficult and time-consuming,
and quite honestly are just almost impossible to clearly manage
the process without a full-time person in place. So the
changing in the way that the program is administered.
The other areas that we most definitely could hopefully
spur more credit unions to getting involved is taking that SBA
loan, the entire loan, and changing the cap so that way it does
not go against a credit union's lending cap. If you were to
free that counting against the lending cap, more credit unions
would be encouraged to invest the time, effort, and staff costs
in order to get into that program. And it is, quite honestly, a
time-intensive and expensive way of doing business, one that
credit unions can serve in, but right now the way that the laws
are currently written it is very preclusive.
Ms. Chu. And specifically in terms of reducing the level of
expense to participate in the SBA program, like what
specifically, what would be one suggestion that you would have?
Mr. Farmakides. There is a number of suggestions. But the
one that I think to reduce the expense that we would want to
have is lowering the cap, just lifting the cap entirely,
because then it frees us up to make those decisions across the
board both in commercial real estate finance, SBA lending, then
also working lines of credit that in essence will allow us to
do a better job managing our expenses against those type of
loans.
Ms. Chu. I see.
Ms. Wiersch, you stated in your testimony that one factor
in reduced credit supply for small businesses is a decade-long
shift in the financial industry away from this type of lending.
In your opinion, what could we do to reverse this trend?
Ms. Wiersch. You know, the trend really, if you look at the
data you can go back even to the 1980s, where we had 17,000
banks in our country, and we are down to about 7,000 now. And
most of that consolidation has taken place in the smallest
category, you know, the small community banks. And, you know,
whether that trend can be reversed, you know, I am not sure I
can say that I see any evidence that is, you know, likely or in
any way possible. I am sure it is possible, but I mean there is
just no signal that that is even something that could happen.
And as I am, you know, hearing the concerns about
regulation and the pressure that puts on community banks, I
would imagine that that is certainly a concern. We have not
done any research to say that, you know, there are different
factors forcing the regulation--or the consolidation.
Regulation, I imagine, is just one of many factors in that. But
I don't see any indications that the trend is changing.
Ms. Chu. And, well, in terms of reversing this trend, is
there any kind of additional Federal program that could fill
the gap?
Ms. Wiersch. I have not looked at anything or seen anything
in that regard.
Ms. Chu. Okay.
Mr. Stibel, small businesses and startups are responsible
for nearly two-thirds of net job creation. You mentioned in
your testimony that there is a large discrepancy in access to
capital across business size, where small and microbusinesses
face tougher lending standards. SBA has traditionally filled
this void, but small dollar loans have steadily declined since
2007. What should be done to realign SBA's lending activity
with its mission to provide access to capital to our Nation's
smallest businesses?
Mr. Stibel. I think that is a great question, and one that
speaks to the problem that Ms. Wiersch was alluding to, which
is, you know, we keep redefining the line and definition of
what a small business actually is. And, you know, before we can
even have a cogent argument and discussion about what can be
done, we have got to figure out what the actual problem is.
And, you know, small businesses are the same size they were
100 years ago. They don't grow with inflation. Right? A start-
up starts with zero revenues and zero employees always. The
problem is we have redefined the boundaries what a small
business is over and over again, on one hand. And on another,
we have got different definitions. I mean, I am sure if we
asked everyone here, each one of us would have a different
definition for what a small business is. It would be a good,
strong definition. But without a singular definition, I think
it is very hard to start addressing the problem.
With regards to the smallest of businesses, the ones that
are starting and the entrepreneurs and the true Main Street
businesses, the core problem here is because those definitions
keep growing, the government and banks keep shifting towards
the larger businesses, and they ignore the current and present
problem, which is most of our employment comes from the
starting of businesses and their growth.
And, you know, I think the first and foremost thing that
the SBA can do is take a leadership position here. Define what
it means to be a small business or a microbusiness or a
startup, and then put a strong emphasis on lending to those
companies, and encourage that lending first and foremost, and
don't focus on loan size, don't focus on anything other than
the size of a business, from start to whatever the current
definition of small is.
Ms. Chu. Thank you for that.
Mr. Laplanche, I found your suggestions on how to reduce
the underwriting costs to be very interesting. And you are the
CEO of Lending Club. It is a credit platform that employs over
300 people in San Francisco. But could you describe how you
implement your ideas in this credit platform, the Lending Club?
Mr. Laplanche. I can. I shared some of these ideas earlier,
but I can expand on it. Certainly looking at the, like $2
billion in loans that we have made this year, and these were
mostly consumer loans, we have created what we call a credit
review center that is essentially a technology tool that
aggregates data from 25 different data sources. And what is
interesting is now with the Internet there are many, many new
data sources that are created on an ongoing basis, and many new
things you can learn about individuals or small businesses.
In the case of individuals, there are privacy issues, there
are FCRA issues. In the case of small businesses, with the
authorization of the business, that helps us be more flexible
and access more freely some of these data sources. So I
mentioned Yelp ratings, Angie's List ratings. Many small
businesses, Main Street businesses, whether it is a hair salon
or restaurant, have a Facebook page. The number of likes on
their Facebook page is an indicator of a trend in the business.
The number of tweets and retweets, so the activity on Twitter
is also an indicator of performance of the business.
There are data sources that are not readily available but
can be accessed through partnerships. So, for example, the
ability to connect to UPS or FedEx and get shipping data about
a business, it is a third-party validation of that shipping
data, and get that data collected and analyzed automatically is
another sort of indication of performance and a forward
indicator of business activity.
So there are all these data sources that are available
either publicly or through partnerships with companies that
service small businesses, that because we are operate online in
a way that utilizes technology we can connect to and analyze
quickly and incorporate in the decision. But then the very
interesting things we do is the capital can come from many
different data--very different sources. And we have
partnerships with a number of banks. So now over seven
community banks are investors on the Lending Club platform and
can sort of buy loans from Lending Club this way.
Ms. Chu. Thank you for that.
And, Mr. Green, as you know, one of the provisions of the
Dodd-Frank Act known as the Collins amendment increases the
minimum capital requirements on large financial institutions,
while exempting bank holding companies with assets of $500
million or less. This encompasses the overwhelming majority of
all community banks. Will this provision help to level the
playing field and allow community banks to better compete with
big banks?
Mr. Green. I think, Congresswoman, when you look at all the
regulation combined, you know, what you mentioned on Dodd-
Frank, and then you go back to Basel III, Basel III goes into
the larger banks, but that will ultimately come down to the
smaller banks, there might be a window where the smaller
institutions, below $500 million, you know, might have a slight
advantage over the large ones as it relates to capital. But the
general thought is that that, like most other regulations, will
continue to filter down and ultimately impact them, and that
would change as well.
Ms. Chu. Okay. Thank you. I yield back.
Chairman Rice. Thank you, Ms. Chu.
Ms. Wiersch, you mentioned the decline in the number of
small banks. In your data at the Federal Reserve, do you know
what is the primary source of capital for small businesses?
Ms. Wiersch. Well, in terms of where small businesses get
funding, we have some information on this. We know from an NFIB
comprehensive survey that 85 percent of small businesses
identify a commercial bank as their primary financial
institution. Some of the information outside of the commercial
bank area we don't have a real good idea of who the borrower
is. So we have limited information----
Chairman Rice. You mean the lender, right? You mean the
lender, not the borrower.
Ms. Wiersch. I am sorry. Well, no, who the borrower is.
Like, if you are looking at aggregate numbers for finance
companies and who their--we don't know often who they are
lending to. We know total loan volume, for example.
Chairman Rice. But the NFIB says 85 percent of small
businesses identify commercial banks as their primary source.
Ms. Wiersch. That is correct.
Chairman Rice. And would you say those would be large
commercial banks or small commercial banks, or do you have any
data on that?
Ms. Wiersch. There isn't any specific breakdown on that.
Now, what I can tell you is that there has been a shift in the
commercial bank area where small businesses are lending from.
And that shift has taken it from a little over a decade ago
small community banks had a 51 percent market share of the
small loan market, and that has completely shifted. So now the
large banks have the largest share of the small loan market and
the community banks share has shrunk significantly.
Chairman Rice. Now, additional Federal regulation, whether
it be Dodd-Frank or any other Federal regulation, increase
compliance cost. Correct?
Ms. Wiersch. Yes.
Chairman Rice. So that just makes it more difficult to do
business. Correct?
Ms. Wiersch. I would say so.
Chairman Rice. So if we are saying that, you know, small
banks are declining, that historically they have had over half
of the small business loans, wouldn't it be logical to assume
that additional Federal regulation is one of the reasons why
they are disappearing and small businesses are now moving to
larger banks?
Ms. Wiersch. I don't have any research to definitively say
that. But, you know, certainly those are all factors in the
trends that we are seeing.
Chairman Rice. Thank you, ma'am.
Mr. Stibel, you said something that was really interesting
to me. My primary focus is jobs and American competitiveness.
And I truly believe that competitiveness is measured in small
degrees. You know, we are competing around the world. It is not
major things, it is small degrees, because everybody is trying
to compete, and everybody tries to do the best they can. And
one of our primary advantages historically in America has been
access to capital.
You mentioned that small businesses don't have access to
capital these days and that they have increased revenue, but
they are not adding jobs because they don't have access to
capital. Is that correct?
Mr. Stibel. That is, yes.
Chairman Rice. So can we translate that an increased
presence of the Federal Government in the banking system
through Dodd-Frank has led to a reduction in jobs?
Mr. Stibel. The cause and effect between I think is a bit
hard to dissect and pinpoint on either a single piece of
legislation or any type of regulation. You know, regulation can
be good or bad. But I think it is causing pain points right
now. And, you know, ultimately, without lending you are not
going to have job growth. You know, as I said earlier and you
saw in that written testimony, we have now got some clear
evidence that shows that, you know, America's small businesses
are getting back on their feet. But America's individuals, the
employees, are not.
And, you know, we are seeing this in payroll numbers, we
are seeing this in revenue growth personally. So in terms of
people's income. And then we are seeing this in terms of a lack
of an economic recovery on the job side, right, the jobless
economy. And I think a lot of this does come down to the
banking sector. And, you know, included in that is regulation.
And, you know, we can do a lot more from that standpoint to
free up that access to capital to the best businesses right now
in our economy. And, you know, the irony is that it's the
smallest businesses. They are the hardest to determine. They
are often the hardest to find when you see more and more
banking consolidation. But they tend to be the best ones for
sustained growth, for job growth. And ultimately, it is those
small businesses that will become the next large businesses.
Chairman Rice. And so if Dodd-Frank makes it significantly
more difficult to comply with regulatory burdens and small
banks go out of business, then that is just that much less
access to capital for small businesses. Correct?
Mr. Stibel. If we see more and more small community banks
and alternative sources of lending either disappearing, those
banks going out of business, or becoming more restrictive in
terms of how they lend to small businesses, then absolutely we
will see less capital flowing into small businesses, and
ultimately we will see less job growth.
Chairman Rice. Ms. Wiersch, Dodd-Frank was passed on the
theory that we were trying to prevent what happened in the
financial crisis from happening again and keeping financial
institutions from becoming too big to fail. Correct?
Ms. Wiersch. Yes.
Chairman Rice. All right. So, in your opinion, does the
regulatory burden under Dodd-Frank fall disproportionately on
bigger banks or smaller banks?
Ms. Wiersch. I can't say. I mean, my research did not
address that specifically.
Chairman Rice. Thank you, ma'am.
Mr. Green, under Dodd-Frank does the regulatory burden fall
more disproportionately on larger banks or smaller banks?
Mr. Green. Mr. Chairman, it does fall more
disproportionately on the smaller banks than the larger banks.
The cost, as I mentioned, is a fixed cost spread over smaller
assets. The restrictive nature of some of the documentation,
underwriting standards, all of those type things limit also the
ability to make certain type loans.
Chairman Rice. Thank you, sir.
Mr. Laplanche, you mentioned something that was very
interesting to me. You said that no underwriting process will
ever be better than the relationship between a borrower and a
community banker. And why is that, sir?
Mr. Laplanche. I think it comes back to the fourth C of
credit, character. And I think especially for small businesses
and for startups, there is just not a lot of data you can look
at.
Chairman Rice. Okay. So it comes down to I call it
community banking or relationship banking. Hard to quantify and
put in a file. Correct?
Mr. Laplanche. That is right.
Chairman Rice. And the effect of the regulations under
Dodd-Frank are to try to make every loan fit in this box.
Correct?
Mr. Laplanche. That is my understanding. I am no expert
in----
Chairman Rice. So you take that discretion out, you
eliminate that discretion, and the effect of that, in my
opinion, is less lending to small business. Would that be a
logical conclusion?
Mr. Laplanche. That seems to be a logical conclusion, yes.
Chairman Rice. Mr. Green, would you agree with that?
Mr. Green. Yes, sir, I would.
Chairman Rice. Let's talk for a minute about, so if we are
taking the relationship banking off the table, who does that
affect? Does that affect more large businesses that want to
borrow with high income and plenty of assets, or does that
affect more small businesses that want to borrow, start ups and
so forth?
Mr. Green. It affects the smaller businesses. Again, the
quality of the financial information for a smaller business is
not as robust as a larger business. And as a result, you have
to rely more on relationships, knowledge of that customer,
their community, their competitors, things that are intangible
for smaller businesses, smaller owners than you would larger
businesses.
Chairman Rice. So we are penalizing small banks with this
additional regulation under Dodd-Frank, we are penalizing small
businesses with this additional regulation under Dodd-Frank.
Ms. Wiersch, where do most of the jobs come from, big
businesses or large businesses?
Ms. Wiersch. If you looking back to the 1970s, the highest
net job creation rate is for among the smallest of businesses.
Chairman Rice. Thank you very much.
Mr. Farmakides, do you all do mortgage loans?
Mr. Farmakides. We do, sir.
Chairman Rice. Are you familiar with these new qualified
mortgage regulations?
Mr. Farmakides. I am, sir.
Chairman Rice. How is that going to affect your mortgage
lending?
Mr. Farmakides. It is going to create some significant
issues for us.
Chairman Rice. All right. Now, so if somebody comes in with
high income and plenty of assets, is that going to affect the
loan to them at all, these qualified mortgage rules?
Mr. Farmakides. No, it is not.
Chairman Rice. But somebody who comes in with a
relationship with you guys, that you may recognize that they
might not have quite a 41 percent loan to whatever that number
is, income to loan ratio, but you feel like they are good for
the loan and you otherwise would have made that loan in the
past, are you going to be able do that now under this Dodd-
Frank?
Mr. Farmakides. Under great difficulty.
Chairman Rice. It is going to be very difficult to do.
Mr. Farmakides. Nonqualified mortgage.
Chairman Rice. So it is going to make it harder for you to
loan to moderate income, middle class people, but it is not
going to affect the higher income people. Is that correct?
Mr. Farmakides. It is going to make it more difficult.
Chairman Rice. So we are penalizing small banks, we are
penalizing small businesses, we are penalizing low and moderate
income people, and we are preventing job creation. Other than
that, this is a great law. Thank you.
I am going to defer.
Mr. Payne.
Mr. Payne. Thank you, Mr. Chairman.
And this is, I guess, a question any panelist could answer.
You know, it has been stated today that there is a weaker
demand for credit as an issue in most of your testimonies.
Should we expect this demand to return to prerecession levels
or accept weak credit demand and credit alternatives as the new
norm or the new trend?
Mr. Green. I will start out. The uncertainty in the economy
limits the small business. They are more hesitant to invest in
capital goods to expand because the future is less certain. As
a result, that has created less demand. If there is more
clarity about the future and elimination or reduction in
uncertainty, I think you will see greater expansion in the
economy, greater capital expansion, greater job creation, which
will lead to more loan demand.
Mr. Farmakides. I just am going to give a slightly
different picture here from a credit union perspective. We are
in the last year seeing greater demand for smaller lines of
credit. We are talking lines of credit under $250,000, more
opportunity. But we are still not able to serve that. So we are
seeing greater opportunity in 2013. We have closed 13 loans, 10
of them to small businesses, 2 of which were startups, small
working capital lines of credit that currently the market isn't
providing that capital access. And because of the current caps
that are in place, we are having a really hard time getting
that money out there. So there is regulatory caps that we would
hope could be modified in order to allow us to make those type
of loans.
Mr. Stibel. And I would just add to the distinction between
those two last comments and say I actually believe that the
demand is there. And we are seeing that with the surveys that
we are doing to the small businesses out there. It is more the
desire that is lacking right now.
Part of that is certainly uncertainty. A big part of that
is frustration, whether it is regulatory, whether it is just
the banks turning, you know, turning businesses down throughout
the recession. But the demand is absolutely there. And once,
you know, once businesses become more comfortable that the
loans are available you will see lending improve.
Mr. Payne. Okay.
Yes, sir.
Mr. Laplanche. If I might add, I think that is absolutely
right. And the supply and demand are very tightly intertwined.
A survey from the Federal Reserve Bank of New York shows that
again, out of 70 small business owners who wanted capital, 29
did not even apply. So there is a self-selection out of the
process for many small business owners. So when they feel
supply of capital will be there, I think we will see demand
come back.
Mr. Payne. Okay.
And, Ms. Wiersch, you know, in your testimony, you point
out the fact that more lending is secured by collateral now
than before the great recession. Do you think reversing this
trend would be beneficial for small business? And what could we
do in our capacity in Congress to help support that?
Ms. Wiersch. You know, it is an interesting question.
Looking at the shift in data, we do see that more banks are
requiring collateral. I am not sure that there is a policy
solution to alter, you know, the way that banks are making
their lending decisions and setting the terms of their lending.
But it is important to note that, you know, as property values
rise that will help the collateral side of things so borrowers
can meet bank lending standards.
Mr. Payne. Okay. Thank you.
I yield back, sir.
Chairman Rice. Mr. Mulvaney, you have anything?
Ms. Chu?
Okay. Well, I just have one more question, and that is
what, if anything, just one thing, would you guys suggest that
the Federal Government could do to improve the small business
lending situation?
Ms. Wiersch, I want to start with you and we will go down
the line.
Ms. Wiersch. Of course our research did not attempt to make
any policy recommendations. The one issue I would like to
reiterate is that this is really a complex issue. There are a
lot of factors at play. And any policy action should consider
all of these factors. And addressing just one factor is
unlikely to really move the needle on this problem as, you
know, there are so many things happening here.
Chairman Rice. Mr. Stibel.
Mr. Stibel. I think it is as simple as defining what a
small business is. You know, if I had one thing that I would
recommend doing, start there.
Chairman Rice. So this is for SBA lending, is what you are
talking about?
Mr. Stibel. I would love to see it across the board. I
mean, there is a bill right now on the floor for small business
access to capital where they are talking about certain
businesses' funds being upwards of $150 million in size. Puts
our business in the small business category. So I think it is
critically important to do that broadly, and to make sure that
that is disseminated not just through the SBA, but through to
the IRS when they are looking at small business tax credits,
through to banks, both community and large banks, and through
alternative lending sources.
Chairman Rice. Thank you, sir.
Mr. Stibel. You are welcome.
Chairman Rice. Mr. Laplanche.
Mr. Laplanche. So I focus on the data accessibility part of
the equation, because we use so much data as part of the
underwriting. If the government could make more data more
readily available to lenders, I think that would help the
underwriting decision. So we have had discussions with the
Treasury on better access to IRS data and the ability with the
business owner to easily access tax filings so that we can
incorporate this data into the lending decision. That is one
area where the government can help.
Chairman Rice. Thank you, sir.
Mr. Green.
Mr. Green. Thank you. I think, Congressman, Mr. Chairman,
the mountain of regulations that have been levied on the
banking industry has had the unintended consequence of hurting
most, if not all of the community banks. I would hope that
Congress would maybe go back and look at some of those
regulations to see if there is a disparity between what was
originally intended and what has actually happened, maybe
modify some of those, certainly going forward, those that are
in the works to make sure that that does not continue.
I will add that, maybe in closing comments, that there is a
tremendous amount of capacity within the banking industry to
lend to small businesses. The capital levels are the highest
they have ever been. Liquidity is there. Competition is strong.
There are nonbank competitors, like the credit unions, farm
credit, others.
I know the gentleman to my right has mentioned the cap. In
our State, the credit union that--the percentage of business
loans relative to assets at the highest level is below 5
percent. So they have tremendous capacity as well. In fact, I
think nationally less than 1 percent of the credit unions are
at or near that peak. So there is tremendous capacity in the
banks, farm credit system, significant capacity with the credit
unions, and alternative lenders. So if we could find a way,
again, to eliminate or reduce those unfavorable negative
consequences, that would be very helpful.
Chairman Rice. Thank you, sir.
Mr. Farmakides.
Mr. Farmakides. The one thing for us would be to remove the
member business lending cap and reintroduce the Credit Union
Small Business Lending Act from the 112th Congress, which
directs the SBA Administrator to establish programs for credit
unions. I think that would be very beneficial for us.
Chairman Rice. Thank you.
Ms. Chu.
Ms. Chu. If I could ask a follow-up question.
Mr. Stibel, why is the SBA definition of small business not
adequate?
Mr. Stibel. For a couple of reasons. Number one, there is
no single definition. So the definitions right now are by
category. And number two, and this is probably the most
important thing, no one else is using it. And that is the real
reason. What you need is you need a centralized definition that
Bank of America is using, that Wells Fargo is using, that
Lending Club is using, that we are using so that we can
actually have a proper dialogue about what a small business is.
So it is less about what the definition is. It is more about
making sure that everyone follows that definition.
Ms. Chu. Okay.
Chairman Rice. I just want to thank all you witnesses for
being here today. Your testimony has been very enlightening.
Thank you very much for putting up with me. And this hearing is
adjourned.
[Whereupon, at 11:26 a.m., the subcommittee was adjourned.]
A P P E N D I X
Statement by
Ann Marie Wiersch
Policy Analyst
Federal Reserve Bank of Cleveland
before the
Subcommittee on Economic Growth, Tax, and Capital Access
Committee on Small Business
U.S. House of Representatives
December 5, 2013
Chairman Rice, Ranking Member Chu, and distinguished
members of the subcommittee, it is an honor to testify before
you today on the state of small business lending. My testimony
will focus on the decline in lending to small businesses and
the factors that are driving that decline.\1\ My remarks
represent my own views and are not official views of the
Federal Reserve Bank of Cleveland or any other element of the
Federal Reserve System.
---------------------------------------------------------------------------
\1\ The analysis presented in this Statement draws extensively from
the Federal Reserve Bank of Cleveland publication, ``Why Small Business
Lending Isn't What It Used To Be,'' Ann Marie Wiersch and Scott Shane,
2013. (http://www.clevelandfed.org/research/commentary/2013/2013-
10.cfm).
---------------------------------------------------------------------------
Background
Recent industry and media reports provide a mix of
perspectives on the sate of small business lending.
Contradictory messages abound, and often result from
inconsistent definitions of what constitutes a small business
and from the absence of comprehensive and reliable data on
small business lending. Banks and government agencies use a
wide range of parameters to classify firms as small businesses.
One frequently cited definition of what constitutes a small
business is so expansive that it includes more than 99 percent
of the businesses in the U.S. It should not come as a surprise
that we hear so many differing reports about small business
conditions when firms of so many different sizes and industries
are compared with one another by analysts relying on different
definitions of a small business. In addition, the considerable
lack of data on small business lending and the variance in the
size of firms or loans included in the lending data leads to
inconsistency in reporting among the data that are available.
Small business lending has dropped substantially since the
Great Recession. While some measures of small business lending
are now above their lowest levels since the economic downturn
began, they remain far below their levels before it. For
example, in the fourth quarter of 2012, the value of commercial
and industrial loans of less than $1 million--a common proxy
for small business loans--was 78.4 percent of its second-
quarter 2007 level, when measured in inflation-adjusted
terms.\2\
---------------------------------------------------------------------------
\2\ As reported by the Federal Deposit Insurance Corporation
(http://www2.fdic.gov/qbp/). This report focuses on traditional
commercial bank lending, as it is the most frequently utilized source
of small business credit. According to a 2011 survey by the National
Federation of Independent Businesses (http://www.nfib.com/research-
foundation/surveys/credit-study-2012), 85 percent of businesses
reported that a commercial bank was their primary financial
institution, while only 5 percent has such a relationship with a
nondepository financial institution (such as private finance
companies).
Some policymakers are concerned that the decline in small
business lending may be hampering the economic recovery. Small
businesses employ roughly half of the private sector labor
force and provide more than 40 percent of the private sector's
contribution to gross domestic product. If small businesses
have been unable to access the credit they require, they may be
---------------------------------------------------------------------------
underperforming, slowing economic growth and employment.
Industry participants, including small business owners,
bankers, and regulators have offered differing reasons for the
decline in lending. However, recent analysis by the Federal
Reserve Bank of Cleveland shows that there is no single
explanation, but rather a number of factors driving this trend.
Fewer small businesses are interested in borrowing than in
years past, and at the same time, small business financials
have remained weak, depressing small business loan approval
rates. In addition, collateral values have stayed low, as real
estate prices have declined, limiting the amount that small
business owners can borrow.
Furthermore, increased regulatory scrutiny has caused banks
to boost their lending standards, resulting in a smaller
fraction of creditworthy borrowers. Finally, shifts in the
banking industry have had an impact. Bank consolidation has
reduced the number of banks focused on the small business
sector, and small business lending has become relatively less
profitable than other types of lending, reducing some bankers'
interest in the small business credit market.
Because none of these factors is the sole cause of the
decline in small business credit, any proposed intervention
should account for the multiple factors affecting small
business credit.
Weaker Demand for Credit
Small businesses were hit hard by the economic downturn.
Analysis of data from the Federal Reserve Survey of Consumer
Finances reveals that the income of the typical household
headed by a self-employed person declined 19 percent in real
terms between 2007 and 2010. Similarly, Census Bureau figures
indicate that the typical self-employed household saw a 17
percent drop in real earnings over a comparable period.\3\
---------------------------------------------------------------------------
\3\ Federal Reserve Survey of Consumer Finances (http://
www.federalreserve.gov/econresdata/scf/scf--2010.htm):
Census Bureau: Income, Poverty, and Health Insurance Coverage in the
United States: 2010 (http://www.census.gov/prod/2011pubs/p60-239.pdf).
Weak earnings and sales mean that fewer small businesses
are seeking to expand. Data from the Wells Fargo/Gallup Small
Business Index--a measure drawn from a quarterly survey of a
representative sample of 600 small business owners whose
businesses have up to $20 million a year in sales--show that
the net percentage of small business owners intending to
increase capital investment over the next 12 months fell
between 2007 and 2013. In the second quarter of 2007, it was 16
(the fraction intending to increase capital investment was 16
percentage points higher than the fraction intending to
decrease capital investment), while in the second quarter of
2013, it was negative 6 (the fraction intending to decrease
capital investment was 6 percentage points higher than the
fraction intending to increase it). Similarly, the net
percentage of small business owners planning to hire additional
workers over the next 12 months was 24 in the second quarter of
2007, but only 6 in the second quarter of 2013.\4\
---------------------------------------------------------------------------
\4\ Wells Fargo Gallup Small Business Index (https://
wellsfargobusinessinsights.com/research/small-business-index).
Reduced small business growth translates into subdued loan
demand. Thus, it is not surprising that the percentage of small
business members of the National Federation of Independent
Businesses (NFIB) who said they borrowed once every three
months fell from 35 percent to 29 percent between June 2007 and
---------------------------------------------------------------------------
June 2013.
Some of the subdued demand for loans may stem from business
owners' perceptions that credit is not readily available.
According to the Wells Fargo/Gallup Small Business Index
survey, in the second quarter of 2007, 13 percent of small
business owners reported that they expected that credit would
be difficult to get in the next 12 months. By the second
quarter of 2013 that figure had increased to 36 percent. By
contrast, 58 percent of small business owners said credit would
be easy to get during the next 12 months when asked in 2007,
compared to 24 percent six years later.
Reduced Credit Supply
Lenders are approving fewer small business loan
applications, since many firms lack the cash flow, credit
scores, and collateral that banks require. According to the
latest Wells Fargo/Gallup Small Business Index, 65 percent of
small business owners said their cash flow was ``good'' in the
second quarter of 2007, compared to only 48 percent in the
second quarter of 2013.
Small business credit scores are lower now than before the
Great Recession. The Federal Reserve's 2003 Survey of Small
Business Finances indicated that the average PAYDEX score of
those surveyed was 53.4.\5\ By contrast, the 2011 NFIB Annual
Small Business Finance Survey indicated that the average small
company surveyed had a PAYDEX score of 44.7. In addition,
payment delinquency trends point to a decline in business
credit scores. Dun and Bradstreet's Economic Outlook Reports
chart the sharp rise in the percent of delinquent dollars
(those 91 or more days past due) from a level of just over 2
percent in mid-2007 to a peak above 6 percent in late-2008.
While delinquencies have subsided somewhat since then, the
level as of late 2012 remained at nearly 5 percent, notably
higher than the pre-recession period.
---------------------------------------------------------------------------
\5\ 2003 Survey of Small Business Finances (http://
www.federalreserve.gov/pubs/oss/oss3/ssbf03/ssbf03home.html).
More lending is secured by collateral now than before the
Great Recession. The Federal Reserve Survey of Terms of
Business Lending shows that in 2007, 84 percent of the value of
loans under $100,000 was secured by collateral. That figure
increased to 90 percent in 2013. Similarly, 76 percent of the
value of loans between $100,000 and $1 million was secured by
collateral in 2007, versus 80 percent in 2013.\6\
---------------------------------------------------------------------------
\6\ Survey of Terms of Business Lending (http://
www.federalreserve.gov/releases/e2/default.htm).
The decline in value of both commercial and residential
properties since the end of the housing boom has made it
difficult for businesses to meet bank collateral requirements.
A significant portion of small business collateral consists of
real estate assets. For example, the Federal Reserve's 2003
Survey of Small Business Finances showed that 45 percent of
---------------------------------------------------------------------------
small business loans were collateralized by real estate.
On the residential side, Barlow Research, a survey and
analysis firm focused on the banking industry, reports that
approximately one-quarter of small company owners tapped their
home equity to obtain capital for their companies, both at the
height of the housing boom and in 2012. The value of home
equity has dropped substantially since 2006. According to the
Case-Shiller Home Price Index, the seasonally adjusted
composite 20-market home price index for April 2013 was only
73.8 percent of its July 2006 peak.
On the commercial side, the Moody's/Real commercial
property price index (CPPI) shows that between December 2007
and January 2010, commercial real estate prices dropped 40
percent. While prices have recovered somewhat since then, the
index (as of May 2013) is still 24 percent lower than in 2007.
Tighter Lending Standards
At the same time that fewer small businesses are able to
meet lenders' standards for cash flow, credit scores, and
collateral, bankers have increased their credit standards,
making even fewer small businesses appropriate candidates for
bank loans than before the economic downturn. According to the
Office of the Comptroller of the Currency's Survey of Credit
Underwriting Practices, banks tightened small business lending
standards in 2008, 2009, 2010, and 2011.
Loan standards are now stricter than before the Great
Recession. In June 2012, the Federal Reserve Board of Governors
asked loan officers to describe their current loan standards
``using the range between the tightest and easiest that lending
standards at your bank have been between 2005 and the
present.'' For nonsyndicated loans to small firms (annual sales
of less than $50 million), 39.3 percent said that standards are
currently ``tighter than the midpoint of the range,'' while
only 23 percent said they are ``easier than the midpoint of the
range.''
Moreover, while banks have loosened lending standards for
big businesses during the recent economic recovery, they have
maintained tight standards for small companies. The Office of
the Comptroller of the Currency's Survey of Credit Underwriting
Practices tracks the changes in lending standards for small and
large customers between 2003 and 2012. The net tightening of
lending standards (the percentage of banks tightening lending
standards minus the percentage loosening them) was slightly
greater for small businesses than large businesses in 2009 and
2010. However, in 2011 and 2012, there was a net tightening of
lending standards for small businesses, despite a net loosening
for big businesses.\7\
---------------------------------------------------------------------------
\7\ The Office of the Comptroller of the Currency Survey of Credit
Underwriting Practices (http://www.occ.gov/publications/publications-
by-type/survey-credit-underwriting-practices-report/index-survey-
credit-underwriting-practices-report.html).
While banks adjust lending standards for a number of
reasons, there is some evidence that heightened scrutiny by
regulators had an impact during and after the Great Recession.
Recent research quantifies the impact of tighter supervisory
standards on total bank lending. A study by Bassett, Lee, and
Spiller finds an elevated level of supervisory stringency
during the most recent recession, based on an analysis of bank
supervisory ratings.\8\ This research concludes that an
increase in the level of stringency can have a statistically
significant impact on total loans and loan capacity for several
years--approximately 20 quarters--after the onset of the
tighter supervisory standards.
---------------------------------------------------------------------------
\8\ ``Estimating Changes in Supervisory Standards and Their
Economic Effects,'' William F. Bassett, Seung Jung Lee, and Thomas W.
Spiller. Federal Reserve Board, Divisions of Research and Statistics
and Monetary Affairs, Finance and Economics Discussion Series, no.
2012-55. (http://www.federalreserve.gov/pubs/feds/2012/201255/
201255pap.pdf).
---------------------------------------------------------------------------
Longer-Term Trends
Declines in small business lending also reflect longer-term
trends in financial markets. Banks have been exiting the small
business loan market for over a decade. This realignment has
led to a decline in the share of small business loans in banks'
portfolios. The FDIC reports that the fraction of nonfarm,
nonresidential loans of less than $1 million has declined
steadily since 1998, dropping from 51 percent to 29 percent.
The decades-long consolidation of the banking industry has
reduced the number of small banks, which are more likely to
lend to small businesses. Moreover, increased competition in
the banking sector has led bankers to move toward bigger, more
profitable, loans. That has meant a decline in small business
loans, which are less profitable because they are banker-time
intensive, are more difficult to automate, have higher costs to
underwrite and service, and are more difficult to securitize.
Conclusion
The decline in the amount of small business credit since
the financial crisis and Great Recession is unmistakable. The
most recently available data put the inflation-adjusted value
of small commercial and industrial loans at less than 80
percent of their 2007 levels. While different industry
participants offer different reasons for the drop in small
business credit, a careful analysis of the data suggests that a
multitude of factors explain the decline.
The forces unleashed by the financial crisis and Great
Recession added to a longer-term trend. Some banks have been
shifting activity away from the small business credit market
since the late 1990s, as they have consolidated and sought out
more profitable sectors of the credit market. Small business
demand for lending has decreased, as fewer small businesses
have sought to expand. Credit has also become harder for small
businesses to obtain. A combination of reduced
creditworthiness, the declining value of homes (a major source
of small business loan collateral), and tightened lending
standards has reduced the number of small companies able to tap
credit markets.
This confluence of events makes it unlikely that small
business credit will spontaneously increase anytime in the near
future. Given the contribution that small businesses make to
employment and economic activity, policymakers may be inclined
to intervene to promote greater access to credit for small
business owners. When considering means of intervention,
however, it is important to be cognizant that multiple factors
are affecting small business credit demand and supply. Any
proposed solutions should consider the combined effect of all
of the factors involved.
UNITED STATES HOUSE OF REPRESENTATIVES
COMMITTEE ON SMALL BUSINESS
SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS
HEARING: ``EXAMINING THE POST-RECESSION SMALL BUSINESS LENDING
ENVIRONMENT''
TESTIMONY OF JEFF STIBEL, CHAIRMAN AND CEO OF DUN & BRADSTREET
CREDIBILITY CORP.
DECEMBER 5, 2012
Thank you Chairman Rice, Ranking Member Chu and the
Committee for inviting me to testify on this important topic.
By way of background, I am currently Chairman and CEO of Dun &
Bradstreet Credibility Corp. Dun & Bradstreet Credibility Corp.
is the leading provider of credit building and credibility
solutions for businesses. Dun & Bradstreet Credibility Corp.
provides the only real business credit monitoring solution
available to companies looking to monitor and impact their own
business credit profile. Our leading credit monitoring products
are used by hundreds of thousands of companies interested in
helping protect their business reputation. Dun & Bradstreet
Credibility Corp. additionally resells D&B solutions that help
businesses gauge their potential risk by tracking the credit
and creditworthiness of the companies with which they do
business.
Dun & Bradstreet Credibility Corp. is headquartered in Los
Angeles, CA with offices throughout North America.
Current State of the Economy
Across the United States, businesses are recovering from
the recession. The US GDP is expanding and the stock market is
performing well. Our proprietary data shows similar progress.
In order to effectively analyze the marketplace, we divide
businesses into four categories by size: micro (less than
$500,000 in annual revenue), small (less than $5 million in
annual revenue), medium ($5 million to $100 million in annual
revenue) and large (over $100 million in annual revenue).
Across each of these categories, businesses are doing well and
we are seeing strong growth in annual revenues.
But when you look at the specific categories, an
interesting trend emerges. It turns out that the smaller the
business, paradoxically the better the performance. This is in
contrast to what most people believe is happening. Yet, the
numbers bear out the fact that the growth of sales are
increasing the fastest in the smallest of businesses. The micro
segment is performing best, followed by small, medium, and
large. Small business growth is accelerating at a much faster
pace than that of its larger counterparts. In 2013 alone, micro
business revenue on average grew by 2.14% while small business
revenue grew by 1.18%. Yet medium business revenue stayed
relatively flat, losing 0.2% overall. The large businesses on
average in our data decreased revenue by 1.56%.\1\
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\1\ Proprietary data is composed of D&B Credibility Corp. data, and
various other sources compiled by D&B Credibility Corp. for the year
2013.
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Current State of Job Growth
Despite the economic progress driven by business
performance since the recession, the country has not recovered
jobs at the same pace. Job growth, while improving, is slow by
post-recession standards: The New York Times reported last year
that percentage change in payroll, from business cycle trough
to business cycle peak, averaged from all previous recessions,
is 15%.\2\ For the current recovery it is 2%. By contrast, in
an average recovery, corporate profits rise 38 percent from
trough to peak. In this recovery, they have risen 45 percent.
We have better than average profitability and much, much lower
than average job growth.
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\2\ Catherine Rampell, ``Is This Really the Worst Economic Recovery
Since the Depression?, New York Times, August 10, 2012.
Our proprietary data supports the conclusion that on
average, job growth has been slow relative to other recessions.
As with revenue growth, the lack of job growth is largely a
tale of two economies. However, for job growth, it is the
smallest businesses that are suffering, not thriving. Our data
show that the rate of job growth is the lowest in the smallest
business categories. In 2013, large businesses increased
employment by 5.53%, medium-sized businesses increased
employment by 0.93%, small businesses by 0.57%, and micro by
only 0.44%.\3\ It is a great paradox, an alarming problem, that
even though small businesses are growing revenues at a faster
pace, they are adding the fewest jobs.
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\3\ Proprietary data is composed of D&B Credibility Corp. data, and
various other sources compiled by D&B Credibility Corp. for the year
2013.
Jobless Recovery is Due to Weak Hiring at the Small
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Business Level
Given that in past economic cycles, small businesses were
the primary driver of employment growth, we can infer from our
results that the disconnect between business success and job
growth is one of the reasons for the ``jobless recovery.'' When
you dissect the data further and analyze revenues per employee,
a proxy for productivity, the results bear out this conclusion.
Employee productivity is rising at the fastest rate for the
smallest businesses, as measured by sales growth per employee.
From January to November 2013, micro businesses experienced
1.86% growth per employee, small businesses 0.75%, medium
businesses -1.14%, and large businesses -6.72%.\4\ (See
attached figure.) The smaller the business, the greater the
productivity gain on average per employee. Yet despite this
gain in productivity, small businesses are not adding to their
employment rosters at the same pace. Strong sales and greater
productivity, without employment growth, yields a jobless
recovery.
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\4\ Proprietary data is composed of D&B Credibility Corp. data, and
various other sources compiled by D&B Credibility Corp. for the year
2013.
Small businesses not only employ almost half of the private
sector, but they are also responsible for the lion's share of
new jobs created. In the past 20 years, about two-thirds of all
net new jobs were created by small businesses.\5\ SBA data show
that small businesses (those with 500 or less employees) amount
to 99.7% of all businesses and employ 49.1% of private sector
employment.\6\ This means that small business job growth is
critical after a recession.
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\5\ SBA Office of Advocacy Frequently Asked Questions, Published
September 2012.
\6\ SBA Small Business Profile, Published February 2013.
Of those small businesses, microbusinesses are particularly
important to job growth. According to the Association for
Enterprise Opportunity (AEO), 92% of all U.S. businesses are
microbusinesses. Despite their size, the direct, indirect, and
induced effects of these microbusinesses on employment amounted
to 41.3 million jobs, or 31% of all private sector employment.
``If one in three Main Street microbusinesses hired a single
employee, the United States would be at full employment,'' the
AEO reported in 2011 and reiterated in a new report last
month.\7\
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\7\ ``Bigger than You Think: The Economic Impact of Microbusiness
in the United States,'' reported by Association for Enterprise
Opportunity (AEO), 2013.
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The Root Problem Is Access to Capital
We tend to equate job growth with business success but the
reality is far more nuanced than that. Adding jobs is a capital
investment, not a cash flow issue. Additional employees are
hired for future growth, similarly to how business owners
purchase computers, software, and other capital goods.
Businesses may need to add jobs when revenues and profits rise
but they cannot do so without a capital outlay.
For large businesses, the cost of employment is relatively
low, so this point becomes largely academic. As revenues and
profits rise, the largest businesses simply dip into their
capital reserves to hire more people and grow their businesses.
But small businesses do not have reserves significant enough to
support new employment growth. It is a far bigger investment
for a small business to hire an additional employee than for a
larger business to do so. For microbusinesses, the situation is
even more acute: adding a single employee to a microbusiness--
where the average number of employees is 2.34 \8\--would
require increasing payroll by nearly 50%. For a small business
to increase hiring, they need access to capital.
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\8\ Glenn Muske, Michael Woods, Jane Swinney and Chia-Ling Khoo,
``Small Businesses and the Community: Their Role and Importance Within
a State's Economy,'' Journal of Extension, Vol 45 (1): February 2007.
Today, access to capital for small businesses is a
significant problem. The data we've collected with our partners
at Pepperdine University show a large discrepancy in access to
capital across business size.\9\ (See attached figure). The
largest businesses are able to secure financing with relative
ease and on strong terms, including historically low interest
rates--the United States Federal Funds Rate is currently 0.25%
and the WSJ Prime Rate is 3.25%.\10\
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\9\ Joint survey with the Pepperdine Capital Access Index Survey
Responses, Fourth Quarter 2013
\10\ Interest rate obtained from http://www.bankrate.com/rates/
interest-rates/prime-rate.aspx.
As business size gets smaller, access to capital shrinks
dramatically. 66% of small business owners indicate that the
current business-financing environment is restricting growth
opportunities for their businesses, while only 44% of medium
sized businesses feel this way. 74.2% of small business owners
feel it is difficult to raise new external debt financing,
while only 45.3% of medium size business owners feel this
way.\11\
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\11\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013
Our data show that 28% of micro, small, and medium sized
businesses sought external financing in the past three
months.\12\ Of those, most (57.1%) sought a business bank
loan.\13\ The approval rates vary widely but the trend is
consistent with our other data: 75% of medium-sized businesses
who sought a bank loan were successful, as compared to 34% of
small businesses and only 19% of microbusinesses.\14\ Even
alternative sources of capital that were once thought of as
easy to acquire are becoming difficult for the smallest
businesses in this environment. Of those business owners who
attempted to acquire a business credit card, for example, in
the past three months, only 51% of microbusinesses were
successful, as compared to 62% of small businesses and 75% of
medium-size businesses.\15\ It is alarming that almost half of
all microbusinesses in our data were unable to secure a
business credit card, traditionally one of the easiest sources
of capital.
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\12\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013, p20
\13\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013, p24
\14\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013, p23 plus Special PCA Index Survey Responses for
Businesses with Annual Revenues Under $500K, p16.
\15\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013, p23 plus Special PCA Index Survey Responses for Business
with Annual Revenues Under $500K, p16.
Instead, micro and small businesses are turning to their
personal assets to grow: our survey showed that 46% of micro
business owners transferred personal assets to the business
over the past three months, compared to 40% of small business
owners and only 19.3% of medium business owners.\16\ During the
recession, these assets were largely frozen, but with the
housing market recovering and personal debt expanding, this is
a singular bright spot to the small business capital dilemma.
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\16\ Pepperdine Capital Access Index Survey Responses, Fourth
Quarter 2013, p27 plus Special PCA Index Survey Responses for
Businesses with Annual Revenues Under $500K, p20.
Ultimately, however, small businesses require business
loans to succeed. Access to capital worsened significantly
during the recession, but only for small businesses. Banks
actually increased large business loans (defined by the FDIC as
loans over $1 million) by 23% from 2007 (pre-recession) to 2012
(post-recession). During the same time period, they decreased
small business loans (defined by the FDIC as loans $1 million
and under) by 14%.\17\
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\17\ Federal Deposit Insurance Corporation, Statistics on
Depository Institutions, June 2007 through June 2012.
External data show that banks and other traditional sources
are trying to increase their small business lending, but even
here, this lending is geared mostly to the larger ``small''
businesses. Many big banks now consider a small business as
having up to $20 million in revenues, and evidence suggests
that they are lending to those businesses with revenues closer
to $20 million than $1 million or less. The average SBA backed
7(a) loan in 2012 was $337,730. This is much more than the
average microbusiness would require and likely greater than the
needs of many smaller businesses. In fact, Forbes reported this
year that one firm who surveyed their small businesses seeking
loans found that 59% of them were looking for a loan amount of
$50,000 or less.\18\
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\18\ Ty Kiisel, ``65 Percent Isn't Enough and Job Creation is
Suffocating,'' Forbes, August 13, 2013.
Even definitions of small business have changed. The
problem of defining a small business is not a new one: the War
Mobilization and Reconversion Act of 1944 defined a small
business as either ``employing 250 wage earners or less'' or
having ``sales volumes, quantities of materials consumed,
capital investments, or any other criteria which are reasonably
attributable to small plants rather than medium- or large-sized
plants.'' \19\ The SBA's size standards were changed as
recently as July 2013, when it increased the average annual
revenue size standard from $7 million to $35.5 million for 25
industries.\20\ This encourages banks and other lenders to lend
to larger firms, despite the need from the smallest segment of
our business economy.
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\19\ Robert Jay Dilger, ``Small Business Size Standards: A
Historical Analysis of Contemporary Issues,'' Congressional Research
Service, June 20, 2013.
\20\ Jack Fitzpatrick, ``SBA Revises Small Business Size
Standards,'' USA Today, June 21, 2013.
Without capital, small business will not be in a position
to increase employment. This explains why our data show that
even though small businesses have increasing revenues and
remain optimistic, they are still not adding jobs. Jobs require
capital but it is the largest businesses that are having the
easiest time financing growth, while the smallest businesses
have much less access. As a result, we are investing in the
least productive sector of our economy, which is yielding weak
job growth. Improving small business access to capital would
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make the most positive economic impact.
Solving the Problem: Reduce Lending Risks to and for SMBs
The good news is that the problem is relatively clear:
small business need access to capital in order to increase job
growth. The solution, of course, is somewhat illusory. Previous
attempts have focused on lowering interest rates but that is
not the solution. Banks do not focus primarily on interest rate
reductions in making lending decisions; they pass these costs
on to businesses. Businesses in turn are not as focused as we
might think on rates. We do not hear businesses complaining
about high interest rates. In fact, many smaller businesses end
up turning to alternative lending sources with very high rates
and very high satisfaction. The solution, instead, lies with
reducing risk, from both the lending side and the borrowing
side.
1. On the lending side, we've observed that banks are risk
adverse. In general, the larger the business, the less
likelihood of a complete loan default. Hence, banks tend to
focus on lending to larger businesses. The government has tried
to stem this trend with positive results by providing backstops
through the Small Business Administration. The SBA currently
guarantees 85% of the value of loans up to $150,000 and 75% of
the value of loans of more than $150,000. While this has had a
positive effect on small business lending, small business
lending may benefit from having that distinction be focused,
not on loan size, but on business size. For example, the SBA
could guarantee 85% of the loan value for microbusinesses, 75%
for small businesses, 50% for medium-sized businesses, and zero
for larger companies. This would effectively tier the risk for
banks and incentivize them to lend to the smallest and most
productive businesses.
2. On the borrowing side, many small business owners are
hesitant to take out loans with personal guarantees. The SBA,
traditional banks, and even many alternative lenders require
personal guarantees. For example, the SBA requires all owners
of 20 percent or more of the equity in a business to offer a
personal guarantee, and may even require liens on personal
assets.\21\ When banks require personal guarantees for a
business loan, that loan is essentially the same as a personal
loan. In effect, our economy has no concept of business loans
for small businesses: we only offer personal loans. The most
savvy of business owners know this and it is why our data shows
that many owners avoid business loans in favor of easier and
cheaper personal loans that carry the same risk. This policy is
costing the economy growth and our nation jobs.
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\21\ 7(a) loan repayment terms from Sba.gov.
We believe strongly that helping small businesses access
capital is vital to our nation's recovery, and we have made
this one of our missions at Dun & Bradstreet Credibility Corp.
We launched our Access to Capital initiative in an effort to
foster business lending and educate small business owners on
the many types of financing that may be available to them. We
have held four successful events in the past year, and have
helped thousands of small business owners sit down for one-on-
one meetings with traditional and alternative lenders,
resulting in tens of millions in loan originations. We are also
a partner in the Clinton Global Initiative, where we have
provided over $2.5 million in free products and services to
small businesses across the country who are in need of our
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credit building solutions but cannot afford them.
The best solutions occur when government and the private
sector work together. The government has already done a great
deal for its part. For small businesses, the government can
even further and profoundly influence the growth of revenues
and jobs by reducing risk on both sides of the equation.
[GRAPHIC] [TIFF OMITTED] 85743.001
Testimony of
Renaud Laplanche
Founder & CEO
Lending Club
before the
Subcommittee on Economic Growth, Tax and Capital Access
of the
Committee on Small Business
United States House of Representatives
5th December, 2013
My name is Renaud Laplanche and I am the founder and CEO of
Lending Club, a credit platform that employs over 300 people in
San Francisco. My father was a small business owner; he owned a
grocery store in a small town in France and I spent every day
of my teenage years from 5 am until 8 am before class helping
him in the store. After having started two companies in New
York and San Francisco, residing in the US for the past 14
years and starting a family here, I recently passed my
citizenship test and will soon be a US citizen. Testifying
before this Committee on the state of small business lending in
America is a special moment for me.
Small Businesses are not only a driving force in the US
economy; they are an essential part of the American Dream. I
believe it is our shared responsibility to ensure that these
businesses and their owners have sufficient access to capital
on fair terms.
I have two points I hope to convey to you today. First,
small businesses have insufficient access to credit, and that
situation is worsening. Second, their credit performance as a
group suggests that they should be getting more credit.
1. Small businesses have insufficient access to capital and
that situation is getting worse.
A survey released by the Federal Reserve Bank of New York
in August of this year was the latest to paint a grim picture
of availability of credit to small businesses. Access to
capital was reported as by far the biggest barrier to growth.
Out of every 100 small businesses, 70 wanted financing. Of
those 70, 29 were too discouraged to apply. Of the 41 that
applied for credit, only 5 received the amount they wanted.
Substantially all of these businesses (93%) were looking for
$1M or less in capital. [NY Fed]
This situation has not gotten better: while the overall
volume of loans of more than $1M has risen slightly since 2008,
loans of less than $1M have fallen by 19%. The number of small
businesses with a business loan fell by 33% from 2008 to 2011.
[NFIB]
The problem is worse for the smallest businesses. While
businesses with 20+ employees reported an increase in bank
loans from 2009-2011, the majority of small businesses, which
have fewer than 20 employees, reported a decline with the
smallest businesses suffering the steepest decline. Businesses
with 2-4 employees reported a 46% reduction in bank loans over
the same period. [NFIB]
While traditional sources of capital have pulled back,
alternatives are on the rise. Alternative lenders such as
online lenders and merchant cash advance providers are the
fastest-growing segment of the SMB loan market--recording a 64%
growth in originations in the last 4 years. [Paynet] Many of
these alternative lenders, however, charge fees and rates that
result in annual percentage rates generally in excess of 40%
and, without full transparency, business owners don't always
understand the true cost of the loan. This lack of
understanding can be very harmful to a small business, which
could find itself in a spiral of inescapable debt service.
2. Small Business Loan Performance is Doing Just Fine.
Charge-off rates on small business loans have been below 1%
since March 2012, down from a peak of nearly 3% in 2009. [SBFE]
In contrast, charge off rates on consumer credit cards peaked
above 10% during the financial crisis.
These figures show that absolute loan performance is not
the main issue of declining SMB loan issuances; we believe a
larger part of the issue lies in high underwriting costs. SMBs
are a heterogeneous group and therefore the underwriting and
processing of these loans is not as cost-efficient as
underwriting consumers, a more homogenous population. Business
loan underwriting requires an understanding of the business
plan and financials and interviews with management that result
in higher underwriting costs, which make smaller loans (under
$1M and especially under $250k) less attractive to lenders. By
contrast, larger loans--going mostly to larger businesses--are
more attractive, as they allow underwriting costs to be
amortized over a larger amount and longer loan term.
We believe we have solutions to bring underwriting costs
down and create the conditions for credit to become more
available and more affordable to small businesses in America,
and would be honored to answer the Subcommittee questions in
that regard.
Testimony of
Fred Green
before the
Subcommittee on Economic Growth, Tax and Capital Access
of the
Committee on Small Business
United States House of Representatives
Testimony of
Fred Green
before the
Subcommittee on Economic Growth, Tax and Capital Access
of the
Committee on Small Business
United States of Representatives
Dcember 5, 2013
Chairman Rice, Ranking Member Chu, and members of the
Committee, my name is Fred Green. I am President and Chief
Executive Officer of the South Carolina Bankers Association. We
are the professional trade association that has represented
South Carolina's banks for over 110 years. Our members are both
large and small and collectively have over 99% of the deposit
market share in our state.
I am pleased to share the banking industry's perspective on
the state of the small business lending environment.
It is well-documented how crucial small businesses are to
the national economy. Studies produced by the Small Business
Administration demonstrate that small businesses account for
over half of all jobs in the U.S. and this share of total
employment has been fairly stable over the past few decades.
More importantly, small businesses account for as much as 65
percent of net new jobs created over the past 15 years and most
new job growth during economic recoveries occurs at new and
small firms. Small firms and start-ups promote innovation
because they are more flexible and often more daring than
larger businesses.
Banks are the primary lender to small businesses and their
presence in local communities throughout our nation is critical
to meeting the unique needs of new and developing companies.
There is a symbiotic relationship between the health of a
community and the health of the banks located there. It is why
small business lending is an important part of every bank's
strategy and why banks today provide more than 20 million small
business loans.
Loan demand has improved since the recession, however
remains at relatively weak levels, held back by tremendous
uncertainty about the future. Concerns over changes to taxes,
employment costs and regulation make small business owners less
interested in expanding and incurring new debt. Businesses
simply are not willing to take on additional debt with so much
uncertainty about the economic future they face.
Despite the low loan demand, banks continue to meet the
needs of their customers. In every community, banks are
actively lending and continually looking for lending
opportunities. After declines in loan portfolios since the pre-
recession peak, recent FDIC call report data shows that
outstanding loans have been growing over the last 12 months.
The presence of banks in communities throughout our nation is
critical to meeting the unique needs of small businesses.
Historically, small business loans have been more risky
than other loan types. Small business loan portfolios' credit
metrics are improving but are still below pre-recession levels.
Underwriting standards have forced banks to secure more of
these loans with collateral. The smaller loans, generally
$250,000 and less, are underwritten primarily on the owner's
financial strength and personal assets. Since real estate is
the primary personal asset for many small business owners, and
real estate has decreased in value, this presents another
challenge for banks.
Banks also face another challenge in providing loans to
meet their customer's needs with the most recent wave of
regulations. The cumulative impact of hundreds of new or
revised regulations may be a weight too great for many small
banks to bear. Congress must be vigilant in its oversight of
the efforts to implement the Dodd-Frank Act to ensure that
rules are adopted only if they result in a benefit that clearly
outweighs the burden. Some rules under Dodd-Frank, if done
improperly, will literally drive banks out of lines of
business.
This last point is very important. It is not that these
regulations will just increase compliance costs for banks, but
banks are now, in their strategic planning, being forced to
consider the elimination of certain products to which customers
have grown accustomed. In South Carolina we recognized this
growing concern and held a special conference for top bank
executives recently to address significantly stricter mortgage
regulations and capital standards banks will find themselves
facing beginning next year. Some community banks have already
told us they will most likely have to stop offering residential
mortgage products because of these new lending regulations. And
as we all know, fewer participants in the market means fewer
options for consumers. For many, these community banks are the
only option. In fact, community banks are the only physical
banking presence in one fifth of the counties in the U.S. The
calculus is fairly simple: More regulation means more resources
devoted to regulatory compliance, and the more resources
devoted to regulatory compliance, the fewer resources are
dedicated to doing what banks do best--meeting the credit needs
of local communities. Every dollar spent on regulatory
compliance means as many as ten fewer dollars available for
creditworthy borrowers. Less credit in turn means businesses
can't grow and create new jobs. As a result, local economies
suffer and the national economy suffers along with them.
In my testimony today, I'd like to make three key points:
Demand for Business Loans Remains Weak Due to
Uncertainty.
Banks are Making New Loans, Meeting Demand.
New Regulations Threaten Banks' Ability to Meet
Customer Demand.
I will discuss each of these in detail in the remainder of
my testimony.
Demand for Business Loans Remains Weak Due to Uncertainty
Loan demand has steadily improved since the recession,
however remains at relatively weak levels. Although the economy
continues its slow recovery, there remains tremendous
uncertainty about the future. This uncertainty, particularly
relating to potential changes to taxes and regulation makes
borrowers less interested in adding new debt.
Small business sentiment has yet to recover from the
recession. The National Federation of Independent Business's
(NFIB) Small Business Optimism Index remains at depressed
levels, and has yet to surpass pre-recessionary lows going as
far back as 1980. Moreover, optimism has not seen any
significant improvement in the past two years.
As a result, businesses are not looking to expand. In the
NFIB's October survey, just 6 percent of small businesses see
now as a good time to expand. In fact, 59 percent of the
respondents cited the economic conditions and political climate
alone as the reason not to expand. If businesses are not
expanding, they are not taking out loans to fund expansion.
[GRAPHIC] [TIFF OMITTED] 85743.002
In South Carolina, our banks are reporting the same--that
there is some demand, but economic uncertainty and the
political climate are holding businesses back from making
capital investments to grow their businesses.
Most bankers state that demand is low particularly from
companies with stronger credit profiles. Financially strong
companies are holding back because of the uncertainty generated
by the debate on the budget and the debt ceiling; and over
healthcare cost concerns.
Higher employment costs such as healthcare, taxation and
labor are bigger issues than most realize, especially for the
small-business owner. Our bankers repeatedly report speaking to
companies that are cutting employees to get below the 50-worker
threshold. For these businesses, that means no expansion and
therefore a limited need for bank funding for expansion. One
banker reported a common example. This banker had banked the
local owners of seven fast-food restaurants. The owners
recently refinanced all term debt and extended amortization to
provide better debt coverage in preparation for the impact of
increased healthcare costs. They currently have approximately
150 full time employees and 50 part time employees. They plan
to cut full time employment by at least 50 percent and offset
that by increasing their part time staff. In addition, they
have put all expansion plans on hold. Another business owner is
outsourcing instead of expanding and hiring new employees. He
cites concerns over the rising cost of healthcare as one thing
that keeps him from growing his employment base.
Due to this uncertainty and apprehension about the future,
small business owners' loan levels have decreased. This leaves
bankers to aggressively seek what little business is available,
often taking business from one another; rather than seeing an
expansion of the business market to pre-recession levels due to
increased borrowing. Even though the resulting pricing and
terms from this competition are very favorable to borrowers,
lending levels remain low due to the lack of confidence on the
part of small business owners, not banks' unwillingness to
lend.
Business thrives when there is a level of stability in the
economy. The unknowns associated with providing health care to
employees is just one of many concerns in what business owners
see as a confusing and convoluted environment.
Businesses simply are not willing to take on additional
debt with so much uncertainty about the economic future they
face. In fact, utilization of existing line commitments remains
low at around 50 percent. Said differently, business owners are
using only 50 percent of the dollar loan commitments already in
place.
Banks are Making New Loans, Meeting Demand.
In every community, banks are actively lending and
continually looking for lending opportunities. In spite of the
slowly recovering pace of the economy, recent FDIC call report
data shows that outstanding loans have been growing over the
last 12 months and that after several years of contraction, the
overall portfolio of small business loans has stabilized. The
presence of banks in communities throughout our nation is
critical to meeting the unique needs of small businesses.
[GRAPHIC] [TIFF OMITTED] 85743.003
AIn fact, banks are meeting the majority of loan demand of
small businesses. In the NFIB's October 2013 Small Business
Optimism Index, financing and interest rates were the least
cited concern facing small businesses. In fact, just two
percent of respondents identified this as their chief concern,
a survey low. On the other hand a combined 41 percent of
respondents cited government requirements or taxes as their
greatest concern.
Banks still continue to make loans to creditworthy
borrowers, constantly assessing whether some businesses can
reasonably take on more debt in this economy. In 2012 alone,
banks made $1.8 trillion in new loans and business loan volumes
have grown by 10 percent in the past year alone.
[GRAPHIC] [TIFF OMITTED] 85743.003
BThe pace of business lending is affected by many things,
most importantly being the demand from borrowers. The state of
the local economy--including business confidence, business
failures, and unemployment--and regulatory pressures to be
conservative plays important roles too. The rise in new credit
means that businesses are borrowing more from banks and using
that money to grow and improve the economy.
New Regulations Threaten Banks' Ability to Meet Customer
Demand.
Banks are currently contending with a wave of new
regulations. During the last decade, the regulatory burden for
community banks has multiplied tenfold, with more than 50 new
rules in the two years before Dodd-Frank. And with Dodd-Frank
alone, there are more than 5,500 pages of proposed regulations
and 6,700 pages of final regulations (as of November 19, 2013).
What is frightening to consider is that we are not even half
way through Dodd-Frank's 398 rules that must be promulgated
under the new law.
In many cases, the cumulative impact of the last few years
of new regulation threatens to undermine the community bank
model. Banks certainly appreciate the importance of regulations
that are designed to protect the safety and soundness of our
institutions and the interests of our customers. We recognize
that there will always be regulations that control our
business. But the reaction to the financial crisis has layered
regulation upon regulation, doing little to improve safety and
soundness and, instead, increasing our operating costs and
handicapping our ability to serve our communities.
Community banks pride themselves on being agile and quick
to adapt to changing environments. During the recession, banks
tightened lending standards. Even though underwriting has
loosened some, it is still tighter than before. Yet what will
discourage loosening underwriting standards even further are
the regulatory pressures on small community banks, the banks
that make the majority of the small business loans. New laws or
regulations might be manageable in isolation, but wave after
wave, one on top of another, will undoubtedly overwhelm many
community banks. Given that the cost of compliance has a
disproportionate impact on small banks as opposed to large
banks, it is reasonable to expect this gap to widen even more
as Dodd-Frank is fully implemented.
The cumulative impact of hundreds of new or revised
regulations may be a weight too great for many small banks to
bear. Congress must be vigilant in its oversight of the efforts
to implement the Dodd-Frank Act to ensure that rules are
adopted only if they result in a benefit that clearly outweighs
the burden. As mentioned earlier, some rules under Dodd-Frank,
if done improperly, will cause many banks to eliminate or
drastically limit products and services many businesses have
used for years. New rules on mortgage lending, for example, are
particularly problematic.
In dramatic illustration of this point, a 2011 ABA survey
of bank compliance officers found that compliance burdens have
caused almost 45 percent of the banks to stop offering some
loan or deposit products. In addition, almost 43 percent of the
banks decided to not launch a new product, delivery channel or
enter a geographic market because of the expected compliance
cost or risk.
The bottom line is this--additional regulations mean more
resources devoted to compliance, and dollars directed toward
compliance are dollars that can't be directed toward meeting
the credit needs of local communities. Banks understand
regulation is necessary, but they also understand that
burdensome regulation ultimately means they have fewer dollars
to lend, which means less opportunity for businesses to grow
and create new jobs. As a result local economies suffer and the
national economy suffers along with them.
Conclusion
Banks in South Carolina and across the nation are eager to
serve the financing needs of small businesses. They understand
they play a critical role in their local economies and no bank
has or wants to stop pursuing small-business lending. Yet,
small businesses remain very hesitant on the whole to embrace
expansion due to economic uncertainty, concerns over healthcare
and the political climate. Businesses that are ready to expand,
hire and invest find themselves increasingly apprehensive as a
result of the external turmoil and, as a result, have held off
significantly from enacting growth plans.
This does not mean that banks are not making loans. Our
economy is growing and banks are addressing financing needs.
But these loans are being made to creditworthy borrowers with
vanilla financials; businesses with financials that vary from
norm, sometimes even in small measures, often finding
themselves unable to secure financing.
Finally, regulatory pressures on banks have slowed banks'
ability to provide their communities the economic financing
they need. Regulations restrict what loans can be made and the
amount of regulations greatly increase compliance costs, thus
reducing the ability to lend. The bottom line is that while
banks may be eager to lend, and business may be eager to grow,
the environment that exists at present is hindering efforts by
both to make transactions a reality. As such, it's not only
banks and small businesses that are hurt, but communities as a
whole.
Healthy, properly financed small businesses are absolutely
critical to our communities' economies. Banks understand their
role in this and continue to make every good loan they can,
despite an increasingly difficult lending environment.
Thank you once again for the opportunity to testify.
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Introduction
Good morning, Chairman Rice, Ranking Member Chu and Members
of the Subcommittee. My name is John Farmakides, and I am
testifying on behalf of the National Association of Federal
Credit Unions (NAFCU). Thank you for holding this important
hearing today. I appreciate the opportunity to share our views
on small business lending from a lender's perspective.
Currently, I serve as the President and CEO of Lafayette
Federal Credit Union headquartered in Kensington, Maryland, a
position I have held since 2007. Lafayette has a rich history
of serving the greater Washington, D.C. area and was
established in 1935 offering small personal loans to members.
Today Lafayette has approximately 14,000 members, over 65
employees and more than $366 million in assets. We provide a
full range of financial services including member business
loans through several branches in Maryland, Virginia, and the
District of Columbia. I have been an active member of the
Lafayette community for over 20 years, serving on the
supervisory committee as chairman and as treasurer of the board
before being named President and CEO in 2007. I also have
experience in investment banking and commercial real estate.
In addition to my responsibilities at Lafayette, I also
currently sit on the Regulatory Committee at the National
Association of Federal Credit Unions (NAFCU). As you may know,
NAFCU is the only national organization that exclusively
represents the interests of the nation's federally chartered
credit unions. NAFCU member credit unions collectively account
for approximately 68 percent of the assets of federally
chartered credit unions. NAFCU and the entire credit union
community appreciate the opportunity to participate in this
important and timely discussion.
Background on Credit Unions
Historically, credit unions have served a unique function
in the delivery of necessary financial services to Americans.
Established by an act of Congress in 1934, the federal credit
union system was created, and has been recognized, as a way to
promote thrift and to make financial services available to all
Americans, many of whom would otherwise have limited access to
financial services. Congress established credit unions as an
alternative to banks and to meet a precise public need--a niche
credit unions fill today for nearly 97 million Americans. Every
credit union is a cooperative institution organized ``for the
purpose of promoting thrift among its members and creating a
source of credit for provident or productive purposes.'' (12
Sec. USC 1752(1)). While over 75 years have passed since the
Federal Credit Union Act (FCUA) was signed into law, two
fundamental principles regarding the operation of credit unions
remain every bit as important today as in 1934:
credit unions remain totally committed to
providing their members with efficient, low-cost,
personal financial service; and,
credit unions continue to emphasize
traditional cooperative values such as democracy and
volunteerism.
The nation's approximately 7,000 federally insured credit
unions serve a different purpose and have a fundamentally
different structure than banks. Credit unions exist solely for
the purpose of providing financial services to their members,
while banks aim to make a profit for a limited number of
shareholders. As owners of cooperative financial institutions
united by a common bond, all credit unions have an equal say in
the operation of their credit union--``one member, one vote''--
regardless of the dollar amount they have on account. These
singular rights extend all the way from making basic operating
decisions to electing the board of directors--something unheard
of among for-profit, stock-owned banks. Unlike their
counterparts at banks and thrifts, federal credit union
directors generally serve without remuneration--a fact
epitomizing the true ``volunteer spirit'' permeating the credit
union community.
Credit unions continue to play a very important role in the
lives of millions of Americans from all walks of life. As
consolidation of the commercial banking sector has progressed,
with the resulting depersonalization in the delivery of
financial services by banks, the emphasis in consumers' minds
has begun to shift not only to services provided, but also--
more importantly--to quality and cost of those services. Credit
unions are second-to-none in providing their members with
quality personal financial services at the lowest possible
cost.
Impediments to Credit Union Business Lending
When Congress passed the Credit Union Membership Access Act
(CUMAA) (P.L. 105-219) in 1998, it put in place restrictions on
the ability of credit unions to offer member business loans
(MBL). Credit unions had existed for nearly 90 years without
these restrictions. Congress codified the definition of an MBL
and limited a credit union's member business lending to the
lesser of either 1.75 times the net worth of a well-capitalized
credit union or 12.25 percent of total assets.
CUMAA also established, by definition, that business loans
above $50,000 count toward the cap. This number was not indexed
and has not been adjusted for inflation in the 15 years since
enactment, eroding the de minimis level. Where many vehicle
loans or small lines of credit may have been initially exempt
from the cap in 1998, many of these types of loans that meet
the needs of small business today are now impacted by the cap
due to this erosion. To put this in perspective relative to
inflation, what cost $50,000 in 1998 costs $71,639 today, using
consumer price index data. That is a change that is completely
ignored by current law and greatly hamstrings a credit union's
ability to meet its members' needs.
The mere existence of an member business lending cap acts
as a deterrent for credit unions to start an MBL portfolio
knowing that as their program thrives they will face this
arbitrary threshold and may have to turn members away.
Furthermore, it should be noted that those credit unions that
do have an MBL program are disincentivized from offering
working capital lines of credit given that, regardless of
whether or not the line of credit is actually drawn, it still
counts against the cap. As members of the subcommittee are
aware, working capital lines of credit are critical to small
companies as a way to meet day-to-day cash shortfalls and
manage the needs of a growing business.
It should be noted that the government guaranteed portions
of Small Business Administration (SBA) loans do not count
toward the member business lending cap, but the non-guaranteed
portions do. This could ultimately lead to a situation where a
credit union may be an excellent, or even preferred, SBA lender
and ultimately have to scale back participation in SBA programs
as they approach the arbitrary cap. This would likely hit SBA
Express or Patriot Express loans first, as those have lower
guarantees and thus may have a bigger impact on money available
below the cap. As you know, Patriot Express loans help give our
nation's veterans more opportunities after they return from
serving our country. The member business lending cap can deter
the availability of those opportunities.
Also, pursuant to section 203 of CUMAA, Congress mandated
that the Treasury Department study the issue of credit unions
and member business lending. In January 2001, the Treasury
Department released the study, ``Credit Union Member Business
Lending'' and found the following: ``...credit union's business
lending currently has no effect on the viability and
profitability of other insured depository institutions.'' (p.
41). Additionally, when examining the issue of whether
modifying the arbitrary cap would help increase loans to
businesses, the study found that ``...relaxation of membership
restrictions in the Act should serve to further increase member
business lending...'' (p. 41).
The 2001 Treasury study found that credit unions do not
pose a threat to the viability and profitability of banks, but
that in certain cases, they could be an important source of
competition for banks. It is important to note that credit
unions have a nominal market share of the total commercial
lending universe (approximately 6% of all small business loans
from insured depository institutions), and are not a threat to
other lenders (who control nearly 94% of all small business
loans from insured depository institutions) in this
environment.
A 2011 study commissioned by the SBA's Office of Advocacy
affirms these findings. (James A. Wilcox, The Increasing
Importance of Credit Unions in Small Business Lending, Small
Business Research Summary, SBA Office of Advocacy, No. 387
(Sept. 2011)). The SBA study also indicates, importantly, that
credit union business lending has increased in terms of the
percentage of their assets both before and during the 2007-2010
financial crisis while banks' has decreased. This demonstrates
not only the need for lifting the cap in order to meet credit
union members' demand, but also that credit unions continue to
meet the capital needs of their business members even during
the most difficult of times. One of the findings of the study
was that bank business lending was largely unaffected by
changes in credit unions' business lending. Additional analysis
is the study also found that credit unions' business lending
can actually help offset declines in bank business lending
during a recession.
Bipartisan legislation to address this issue, in the form
of H.R. 688, the Credit Union Small Business Jobs Creation Act,
is pending before the Financial Services Committee. Introduced
by Reps. Ed Royce (R-CA) and Carolyn McCarthy (D-NY) this
legislation would raise the current 12.25% limit to 27.5% for
credit unions that meet certain criteria. One alternative to
the approach in H.R. 688 would be to raise the outdated
``definition'' of an MBL from last century's $50,000 to a new
21st century standard of $250,000, with an indexing of
inflation to prevent future erosion. Furthermore, MBLs made to
non-profit religious organizations, made for certain
residential mortgages (such as non-owner occupied 1-4 family
residential mortgages), made to business in ``underserved
areas'' or made to small businesses with fewer than 20
employees should be given special exemptions from the cap.
The ever-growing regulatory burden being placed on credit
unions also serves to hamper the ability of credit unions to
make business loans, as capital is diverted from lending to
compliance costs. In early February of this year, NAFCU was the
first credit union trade association to formally call on the
new Congress to adopt a comprehensive set of ideas generated by
credit unions that would lead to meaningful and lasting
regulatory relief for our industry (A copy of the letter is
attached to my testimony). Based on feedback from our
membership and the strong expectation for future growth,
regulatory relief on the member business lending front is a key
component of NAFCU's five-point plan. Another important aspect
of this proposal is capital reforms for credit unions, such as
establishing a risk-based capital system and allowing credit
unions to seek access to supplemental capital. Providing
regulatory relief on these fronts will help make sure credit
unions continue to have the capital available to lend our
nation's small businesses.
The Member Business Lending Environment Post Financial Crisis
A November 2013, survey of NAFCU members found that member
business lending is expected to grow over the next twelve
months. On a scale that goes from -100 to +100 (where zero
indicates flat growth), the August-October median growth
expectation for credit unions regardless of geographic location
was 35.6. Furthermore, asset quality continues to improve for
member business loans at credit unions, with charge-offs down
to only 0.38%.
As illustrated in the graph below, the percentage of credit
unions with member business lending programs has been rising
steadily since the financial crisis.
[GRAPHIC] [TIFF OMITTED] 85743.005
While other lenders pulled back on business lending during
the economic downturn, credit unions continued to lend to their
small business members. Furthermore, as those small business
members lost lines of credit from other lenders, they turned to
credit unions to help meet their needs, leading to an increased
demand for credit union business loans.
Member Business Lending at Lafayette Federal Credit Union
Lafayette has seen a need arise from our small business
members to get lines of credit that they have lost from other
lenders. As a result, we have expanded our focus into this area
in 2013. For example, we gave a $125,000 line of credit to a
local bike rental and touring company to help with their cash
flow due to the cyclical nature of their business. This loan
helps them maintain their 8-10 full-time employees in the off-
season (which then grows to 50-60 in season).
While our credit union proudly meets our local communities'
lending needs, the arbitrary member business lending cap is now
having a direct negative impact on how well we can serve our
members. Many small businesses come to us looking for large
lines of credit to help them meet cyclical challenges. However,
any line of credit above $50,000 counts toward our member
business lending cap, even if the funds are not extended. This
fact hampers our ability to meet the needs of many of our small
business members.
So far in 2013, we have done ten commercial and industrial
member business loans averaging out at about $61,000 each,
evidence that most are considered small but are still ``large''
enough to count against the arbitrary cap. Many of our loans in
this area tend to be lines of credit advances aimed at
financing for cash flow purposes or startup costs. We have also
been able to assist very small traditional companies like a
specialty bakery with a single employee-owner and a trucking
delivery service. At the same time, we have made loans to
several consulting firms related to government contracting as
well as an innovative solar energy appliance company.
It is worth noting that Lafayette takes our MBL program
very seriously and we have recruited the appropriate personnel
with the appropriate experience to ensure it is sound and
successful. While others in the financial services industry may
claim credit unions aren't sophisticated enough or able to
attract the correct personnel to make member business loans,
this is simply a misnomer.
SBA Lending at Lafayette Federal Credit Union
Small businesses are the backbone of our economy and an
important source of jobs for Americans. The Small Business
Administration's loan programs serve as an important resource
that helps credit unions provide small businesses with the
vital capital necessary for growth and job creation. However,
utilizing any SBA loan guaranty program requires meeting
stringent government regulations. While we are an approved SBA
7(a) lender, we currently have just one SBA 504 loan
outstanding, and one USDA Business & Industry loan outstanding.
Determining overall applicant eligibility to participate in
an SBA program is nearly as important as determining the
applicant's creditworthiness. Failing to meet certain
eligibility criteria may preclude the applicant from
participating in an SBA guaranteed loan program. Eligibility
criteria includes among other things: size restrictions, type
of business, use of proceeds, credit standards, and meeting a
`credit-elsewhere' test.
If Congress and the SBA were to make it easier for credit
unions to participate in these programs, small businesses
throughout the nation will have greater access to capital at a
time when it is needed most. NAFCU would support SBA loans
being permanently exempted from counting against a credit
union's MBL cap in full. These suggested changes, which allow
credit unions to do more to help our nation's small businesses,
are an important step to help our nation recover from the
current economic downturn.
Conclusion
Small businesses are the driving force of our economy and
they key to its success. The ability for them to borrow and
have improved access to capital is vital for job creation.
Credit unions play an important role in helping our nation's
small businesses get the access to funds that they need. We
want to do more, however, we are hamstrung by an outdated
artificial member business lending cap that ultimately hurts
small businesses. We urge the subcommittee to support
legislation to make it easier for credit unions to meet the
business lending needs of their members and to expand
participation in SBA programs.
We thank you for your time and the opportunity to testify
before you here today on this important issue to credit unions
and our nation's economy. I would welcome any questions that
you may have.
Attachment: NAFCU letter to Chairman Johnson, Chairman
Hensarling, Ranking Member Crapo and Ranking Member Waters
calling on Congress to provide credit union regulatory relief;
February 12, 2013.
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