United States. Congress. House. Committee on Small.

The effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 online

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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 16 of 21)
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Despite the importance of the small business lending market
to banks and borrowers alike, few data about these loans were



179



available in the past. Recently, however, the Congress has been
concerned about the effect of credit contractions on small
business. As a result, federal bank regulators now are required
to collect information annually on small business loans,
beginning with the second-quarter 1993 bank call reports. Banks
are asked for data on two types of business loans- -nonf arm,
nonresidential loans and commercial and industrial loans - in
three size categories: loans less than $100,000, less than
$250,000, and less than $1 million. While this information is
quite informative about the pattern of small business lending, it
must be interpreted with caution. First, the size of the loan,
rather than the size of the business borrower, is used to define
"small business lending." Second, because it is a new survey, it
is likely that numerous reporting errors may have been made by
banks, in some instances the result of a misinterpretation of the
question.

Size of business rather than size of loan is obviously a
preferred measure. Presumably this question was asked in terms
of size of loan for call report purposes to minimize the cost to
banks of complying with the question, since loan size would be
readily available, but size of business would require examining
each loan file. Scanlon (1981) found that loan size did serve as
a good proxy for borrower size for very large loans and for very
small loans, but less so for the middle range. One might be
concerned that when large firms make a partial takedown of a loan
commitment or draw on a large credit line, it would be counted as



180



a small loan. However, this survey asks questions in terms of
"original amounts" of loans, carefully defined to ascertain the
size of the total credit granted to the firm rather than a
particular bank's share of a participated or syndicated credit,
or the size of a particular draw against a line of credit or
commitment . !

Because this is a new survey, bank answers may have suffered
from being on the early portion of a learning curve. In fact,
Berger and Udell (1995) find inconsistencies between the small
business survey data on the call report and the Survey of Terms
of Bank Lending data. In particular, they find that banks
answering the question as to whether all or substantially all of
their nonfarm, nonresidential real estate loans and commercial
and industrial loans had original amounts of $100,000 or less may
have answered in terms of number of loans rather than volume of
loans, as intended. However, this explanation accounts for only
a portion of the general underreporting of original amounts found
by Berger and Udell (1995) . Furthermore, the underreporting is
much more important for the smaller loan sizes. For our study,
we have minimized the problems by using the $1 million or less
loan category as our definition of small business loans; we have
also carefully scrutinized the small loan data for New England,
identifying what appeared to be egregious errors and following up
with a phone call to the bank for an explanation or correction.



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The Importance of Small Business Lending to Banks, by Size of
Bank

The upper panel of Table 1 shows small business loans as a
share of total business loans outstanding at all FDIC- insured
banks in the United States, ordered by bank asset size as of June
30, 1994. Not surprisingly, loans to small businesses account
for most business lending by small banks. Banks are required to
limit their exposure to any one borrower to no more than 15
percent of their equity, and frequently they impose even lower
internal limits. This limit on borrower concentration has the
effect of restricting small banks primarily to small loans.

Perhaps more surprising is the proportion of small business
loans held by the larger banks. For banks with assets of between
$1 billion and $5 billion, small business loans (loans under $l
million) make up 43 percent of their nonfarm, nonresidential
loans and 37 percent of their commercial and industrial (C&I)
loans. Only at the largest banks, those with assets of over $5
billion, does the share of these small business loans drop below
one- third, accounting for only 32 percent of nonfarm,
nonresidential loans and 17 percent of C&I loans. However, this
difference in the shares of small business loans held by large
compared to small and mid-sized banks may change in the next few
years, as the largest banks continue to acquire small and medium-
sized banks.



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Market Shares of Business Loans, by Size of Bank

The lower panel of Table 1 shows the 1994:11 distribution of

i
small business loans among FDIC- insured banks, grouped by the

size of the bank. Mid-sized banks continue to hold large shares

of total outstanding bank loans to small businesses. Bank asset

size categories from $300 million to $1 billion and $1 billion to (

$5 billion each account for approximately 16 percent of the

market .

While small loans do not constitute a particularly large

part of the portfolios of the largest banks, a large bank's share

of total loans to small businesses can be relatively large

because of the size of the overall institution. Banks with

assets over $5 billion hold 29 percent of all small business

loans held by banks. This is a significantly smaller market

share than their holdings of total business loans, but still a

major market share, given that loans to small business make up

only 22 percent of total business loans held by the largest

banks .

The Largest Small Business Lenders

Table 2 lists the top 25 small business lenders in the
country, which include four of the ten largest banks in the
country based on total assets. These four banks account for 7.1
percent of all business loans, but only 2.5 percent of all small
business loans.

This group of 25 banks is somewhat heterogeneous. While a



183



bank must be large to qualify for this list (all are included in
the top 86 banks in the country based on assets) , size alone is
not sufficient. Among the large money center banks located in
New York and Chicago, only Citibank, the largest bank in the
country, is included. Nor is a focus on small business lending
sufficient, for the small business share of business loans of
banks on this list ranges from 54.4 percent down to as little as
7.5 percent. Still, half the banks on the list are also in the
top 2 5 banks by asset size, and half have small business loan
shares in excess of 25 percent.

Many of the largest small business lenders are
superregionals . Five Nationsbank subsidiaries and two Key Bank
subsidiaries are included in the top 25. Many of the large
superregionals have grown rapidly over the past 10 years, as they
acquired smaller banks following regional compacts that relaxed
restrictions on interstate banking. While the acquisition of
small banks that focus on small business loans may have accounted
for their status as major small business lenders, it remains to
be seen whether this concentration in small business loans will
be retained as these banks continue to grow.

While some holding companies appear to have a corporate
strategy that focuses on small business lending, many of the
other major lenders to small business are less clearly targeting
small business lending. For example, the Key Banks have focused
on small business lending, with the two subsidiaries in the top
25 small business lenders each having more than 40 percent of its



184



business loans of a size below $1 million. In contrast, among
the Nationsbank subsidiaries, the percentage of small business
loans to total business loans ranges from 10.8 percent in Texas
to 44.5 percent in South Carolina.

II. Potential Benefits of Large Lenders: Diversification across
Regions and Products

To examine the potential benefits and costs of universal
banking, we focus on the recent experience of banks in New
England for a number of reasons. First, the region has recently
experienced significant problems with credit availability to
small businesses. Thus, the lack of large, well -diversified
national lenders insulated from regional economic downturns is
most starkly apparent in this region. Second, we have a
comprehensive bank structure file for this region, enabling us to
identify mergers, failures, and asset transfers at these banks.
Third, New England has experienced significant consolidation and
de novo entry, making it an ideal region in which to examine the
effects of consolidation and new entry on small business lending.

The upper panel of Table 3 shows small business loans as a
share of total business loans outstanding at all FDIC- insured
banks in New England, ordered by bank asset size as of June 30,
1994. The share of small business loans (less than $1 million)
relative to total business loans is similar to that of the United
States, as shown in Table 1. However, the shares for smaller
loan sizes, particularly at the smaller banks, do show larger



185



differences compared to the nationwide sample. In the bottom
panel, the shares of small business loans held by New England
banks compared to the national sample again differ more the
smaller the bank size class and the smaller the size of loan.
However, for loans of less than $1 million, the primary
difference is that New England banks with less than $100 million
in assets hold a share that is substantially lower than that for
banks nationwide, 17 percent nationwide but only 7 percent in New
England, with the offset appearing in the $300 million to $5
billion bank asset classes.

Ameliorating the Consequences of Regional Capital Shocks

One of the major benefits of having large, well-diversified
lenders is that bank capital shocks will be ameliorated. The
costs of having geographically specialized lenders have been made
particularly clear by the recent experience in New England.
Figure 1 shows aggregate capital-to-asset ratios for commercial
banks in New England and the United States from 1960: IV through
1994:11, with shading indicating recession periods. 2 From 1960
to the mid 1970s, bank capital ratios declined steadily, showing
relatively little sensitivity to recession periods. Both series
temporarily rebounded in 1975 and 1976. The national series then
rose gradually throughout the 1980s and at an accelerated pace in
the early 1990s. In New England, however, the decline continued
until 1983, when the ratio began to rise. This rise was then
interrupted by a dramatic, but temporary, decline in 1989 and



186



1990, followed by a sharp rise in the early 1990s.

Figure 1 also shows that the overall decline in bank capital
ratios was greater in New England than in the rest of the
country. And, unlike the national trend, a final sharp decline
preceded the most recent recession. Not only was the overall
decline sharper in New England, but the subsequent recovery
appears more dramatic. In fact, the particularly sharp initial
rise in the capital ratio in New England was accomplished in
large part through reductions in assets. Had large nationwide
banks been active in New England, the repercussions of the loss
in bank capital in the region would have been significantly
ameliorated. Thus, one of the major features of large nationwide
lenders, diversification across regions and products, should act
to ensure that regional recessions no longer affect such
institutions to the same degree, significantly softening the
regional effects on loan supply of a shock to bank capital in
that particular region.

The extent of the recent reduction in credit availability as
a result of loan supply shocks has been documented in two studies
by Peek and Rosengren (1995a, 1995b) . The first study (1995a)
finds that large New England banks shrank as a result of formal
regulatory actions, with the shrinkage generally occurring in
loans rather than securities holdings. The second study expands
the analysis to include an explicit test that is able to identify
a regulatory- induced constraint on bank loan supply, unlike
recent credit crunch studies that rely on bank capital-to-asset



187



ratios to proxy for supply constraints, which have difficulty
disentangling the loan supply and loan demand components of the
observed reduction in loans.

The evidence surrounding this regulatory- induced event is
inconsistent with the hypothesis that regulatory actions serve as
a proxy for loan demand shocks. In the quarters immediately
prior to a regulatory action, loans were increasing. Then, in
the precise quarter of the regulatory action, loans decreased
abruptly and then continued to decrease. These regulatory
actions occurred at individual institutions at different times
over the entire sample period. Their effects were found to be
significant, even though the estimated equation included a
variety of other variables to proxy for loan demand shocks,
including variables to capture portfolio concentrations of the
individual banks and over 100 time and location dummy variables .
In addition, these loan supply constraints were found to be
particularly important at small banks and in lending categories
likely to be dominated by borrowers dependent on bank financing.

To determine the magnitude of the effect of formal actions
on this study's sample of all New England banks, the following
regression taken from Peek and Rosengren (1995b) was reestimated:

A^Li = a 1+ (e a +a,^i)i% i , e +a 4 ^^{i-M i , t )+pjr iit . 1 *e iit (D

The dependent variable is the change in total loans of bank i
scaled by total assets of bank i. The equation includes a dummy
variable for formal actions (FA) with a value of one for any



188



quarter the bank is under a formal regulatory action and zero
otherwise .

Because formal actions specify a leverage ratio, usually 6
percent, that the bank is legally required to achieve, the most
poorly capitalized banks have the greatest incentive to shrink.
Thus, the magnitude of the effect of formal actions on the change
in loans may differ across banks, in particular because it is
related to a bank's beginning -of -period (end-of -previous-period)
leverage ratio. Consequently, the coefficient on FA has been
specified to be a function of the leverage ratio, with a 3
predicted to be positive. We also have included the leverage
ratio for banks not under a formal action as an argument in the
equation to allow for the possibility that a bank would respond
by voluntarily rebuilding its capital ratio even in the absence
of a formal action. That is, this specification allows one to
distinguish between bank responses that are voluntary and those
that are imposed by regulators. We anticipate that being below
minimum capital requirements may not in itself generate a bank
response to restore its capital position in the absence of formal
regulatory actions, implying that a 3 > a t .

While many of the differences across banks in the demand for
loans will be ameliorated by concentrating on banks in one
geographic region, this study also includes a series of
classification variables intended to control for any remaining
differences in loan demand shocks arising from a bank's size, its
specialization in particular types of lending activities, volume



189



of troubled loans, and bank charter type, as well as a set of
dummy variables for each o.f the six New England states interacted
with a set of quarterly time dummy variables, one for each
quarter in the sample. The estimation technique is a variance
components model. For a more detailed description of the
estimation technique and variables, see Peek and Rosengren
(1995b) .

Using estimates of equation 1 for total loans on the sample
of FDIC- insured New England commercial and savings banks, it is
possible to calculate the total effect of the formal actions on
bank lending. Because leverage ratios with and without formal
actions have different estimated impacts, the effect of the
leverage ratio also must be incorporated in order to calculate
the net impact of formal actions on loan shrinkage. That is, it
is necessary to calculate the magnitude of the effect over and
above what would have occurred because of low leverage ratios in
the absence of formal actions. The total effect of formal
actions is thus calculated as a 2 + (a 3 - aj *K/A (here, the
calculation is -1.33 + (.16 - .03)*K/A) summed over all banks
under formal actions.

Figure 2 shows the path of actual bank loans in New England
during the 1989:11 to 1994:11 period, compared to this study's


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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 16 of 21)