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 21 of 21)
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industry believe that this information will not
adequately reflect the true scope and size of lending
activity to the small business community because the
regulatory definition of a small business loan does not
include a loan secured by the home of the owner. By
not including such lending in the aggregate lending
figure to be disclosed by the regulators, small
business lending activity will be misrepresented.

Moreover, a number of institutions are having
difficulty retrieving small business lending data from
their automated information systems. The requirement
that data be coded by census tract has caused problems
in capturing loans in many rural area. Thus, it is
unlikely that the data release next year on the
industry's lending to small business entities will
accurately reflect the true scope of lending activity.
Additionally, reporting requirements will be exclusive
of non-bank lenders which are playing an increasing
role in lending to small business. Any reporting
requirements should be inclusive to all lending
activity related to small business. However the cost
of obtaining such data only serves to negatively impact
the very efforts which the data serves to support.



247



Congress of the United States

House of lleprescntatioes

iiHtti CongrtBB

Committee on Small Business

:w Kjubum flousc Offirt Building
Washington. PC :aii5-enii



JOHN J. UFALCE. New York



April 30, 1996

Mr. T. Lincoln Monson, Jr.

President, First National Savings Bank of Ipswich

31 Market Street

Ipswich, Massachusetts 01938

Dear Mr. Monson:

Thank you once again for taking the time to testify before our joint Subcommittee hearing on bank consolidation
and its effects on small business lending. Your testimony was a great source of information for us.

As was mentioned during the hearing, time constraints prevented us from asking certain questions and going into
greater detail on others. We also understand that a lack of time may have prevented you from responding in full.
We would greatly appreciate it if you would take some time to review the following questions and answer them
in as great detail as possible. Your answers will be printed in the official record of the hearing's proceedings.

1. In his written testimony, Mr. Aloise of the Bank of Boston lists "credit scoring" as one of several bank
initiatives that are pending to enhance credit availability to small businesses. In testimony before the
Small Business Committee, however, we have heard that "credit scoring"' is not helpful to many small
businesses — in particular start-up companies — who simply do not have the data to meet the requirements
of "credit scoring." First, would you please explain the process of "credit scoring" for the record in as
much detail as possible. Also, would you please comment on whether you believe "credit scoring" will
enhance or curtail credit availability to small entrepreneurs and why.

2. Relatedly, what do you believe would most enhance credit availability to small entities?

3 What are your views on the 1993 small business disclosure rule which requires banks to annually report

all loans made under SI million? In your opinion, does it help small businesses obtain capital? While
no longer likely, if Congress were to pass banking regulatory reform this year, would you support
retaining this disclosure rule?



Once again, we thank you for your contribution and look forward to your response




LINDA SMITH

Chairwoman

Subcommittefbn Taxation and Finance




tion and finance



PETER G. TORKILDSEN

Chairman,

Subcommittee on Government Programs



Ranking Member,

Subcommittee on Taxation and Finance



248



-©The First National Bank



Of P S V\ I C H



T Lincoln Monson. Jr

Chairman of the Board May 10, 1996

President

The Honorable Linda Smith

Chairwoman

Subcommittee on Taxation and Finance

The Honorable Peter G. Torkildsen

Chairman

Subcommittee on Government Programs

The Honorable Martin Meehan

Ranking Member

Subcommittee on Taxation and Finance

Committee on Small Business
Umted States House of Representatives
2361 Rayburn House Office Building
Washington, DC 20515-6315

Dear Madame Chairman and Members of
the Subcommittees:

This is in response to your letter of April 30, 1996, a copy of which is attached for easy
reference I will respond to your questions in the same order that they were presented:

1 Credit scoring is a loan approval technique which has been in long use in
connection with consumer installment lending Its application to small
business lending is more recent What follows is a simplistic conceptual
description of credit scoring. Credit scoring systems are typically developed by
analyzing the historical performance of a portfolio of loans of a single type. e.g.
unsecured personal loans, over its lifetime The analysis is focused on
identifying those characterises of individual loans which are common to loans
which payout in accordance with their original terms Similarly, the analysis
will identify certain characteristics which are common to loans that default or
fail to pay in full. The characteristics are then prioritized and weighted
according to importance The credit application requests information from the
prospective borrower relevant to these characteristics The system applies the
numerical weightings (points) to each characteristic These are added together
and if the total exceeds a pre-determined threshold the loan request is
approved If the score is below the threshold the request is denied
Characteristics might include such factors as current income, length of time in
current job, length of time in previous job. length of time at current address,
length of time at previous address, credit history, etc An applicant who has
been in his or her current job for 10 years might receive more points for this
factor than one who has been in his or her current job for 6 months



249



Could credit scoring be helpful to a start-up company trying to obtain credit?
This answer could be yes or no If the scoring system is applied only to the
company which has no history, the answer is likely to be no However, if the
scoring is applied to the individual(s) sponsoring the company, the answer
could be yes. In the latter situation, the lender would, in fact, be substituting
the credit worthiness of the individual sponsor(s) for the company which has
none There has been a growing practice of doing just this or at least looking at
both the company and its sponsor(s) in the course of making the credit decision.
By the way, lending money to start-up companies is perhaps the most difficult
task for lenders precisely because there is no history of performance. The
financial needs of a start-up are best met with equity which has no current
carrying cost and a very long time horizon Banks really cannot afford to take
on equity like risks with money that belongs to depositors and shareholders.

2 This is a very open ended question Certainly the best enhancer of credit
availability to small businesses is a track record of successful operation
documented by reliable and reasonably detailed financial information State or
Federal Government loan guarantee programs such as those offered by the
Small Business Administration or Massachusetts Business Development Corp
substantially increase the pool of loan funds available to small businesses.
Maintaining these programs is particularly critical to those small businesses
whose performance is at the margin of acceptablity for bank credit approval
purposes.

3 I do not believe that the cited disclosure helps small businesses obtain
additional capital in any significant way For a bank such as The First National
Bank of Ipswich such reporting is entirely superfluous Our Legal Limit is
$1,200,000 our House Limit is $750,000 and our average commercial loan is
probably closer to $150,000 As a practical matter, therefore, the only business
we can lend to is a small business I would not support retaining this
disclosure.

Thank you again for the opportunity to participate in this process. I would be happy to
answer any additional questions you might have.

Very truly yours,



FtjLrA %#*^



250



JAN MEYERS. Ka



JOHN J UFALCE, New Yobk



Congress of the United States

Douse of Representation

KHtti Congress
Committee on Small Business

2501 Rjybuni ttoufic Office Building
TOasfengton, ©£ wh-*m



Apnl 30, 1996

Mr. James G. Zafns, Jr.
President, Danvers Savings Bank
1 Conant Street
Danvers, Massachusetts 01923

Dear Mr. Zafns:

Thank you once again for taking the time to testify before our joint Subcommittee heanng on bank consolidation
and its effects on small business lending. Your testimony was a great source of information for us.

As was mentioned during the heanng, time constraints prevented us from asking certain questions and going into
greater detail on others. We also understand that a lack of time may have prevented you from responding in full.
We would greatly appreciate it if you would take some time to review the following questions and answer them
in as great detail as possible. Your answers will be pnnted in the official record of the heanng's proceedings.

1. In his wntten testimony, Mr. Aloise of the Bank of Boston lists "credit sconng" as one of several bank
initiatives that are pending to enhance credit availability to small businesses. In testimony before the
Small Business Committee, however, we have heard that 'credit sconng" is not helpful to many small
businesses — m particular start-up companies — who simply do not have the data to meet the requirements
of "credit sconng." First, would you please explain the process of "credit sconng" for the record in as
much detail as possible. Also, would you please comment on whether you believe "credit sconng" will
enhance or curtail credit availability to small entrepreneurs and why.

2. Relatedly, what do you believe would most enhance credit availability to small entities?

3 What are your views on the 1993 small business disclosure rule which requires banks to annually report

all loans made under $1 million? In your opinion, does it help small businesses obtain capital? While
no longer likely, if Congress were to pass banking regulatory reform this year, would you support
retaining this disclosure rule?

Once again, we thank you for your contnbution and look forward tovpur response.

Sincerely, j* / J /*

LINDA SMITH PETER G. TORKI



LINDA SMITH
Chairwoman,

1 on Taxation and Finance




Rankin;
Subcom




PETER G. TORKILDSEN

Chairman,

Subcommittee on Government Programs



on Taxation and Finance



251




MAINOfFCCONCCOHAMTST OANVtW. MA 01TC3-2M0



May 20, 1996



The Honorable Linda Smith
The Honorable Peter G. Torkildsen
The Honorable Martin Meehan
Congress of the United States
House of Representatives
Committee on Small Business
2361 Rayburn House
Washington, D.C. 20515-0315

Dear Representatives Smith, Torkildsen and Meehan:

Thank you for providing me the opportunity to amplify my remarks before your
Subcommittee hearing on bank consolidation and its effects on small business lending. I
welcome the chance to discuss in more detail the three specific points raised in your letter
of April 30, 1996.

At best, "credit scoring" is a tool and not the answer to providing credit to small
businesses. Credit scoring is a procedure by which a number of variables, including past
payment history and total debt levels, are applied to predict the ability and likelihood that
an applicant for a small business loan will be able to successfully service debt.

On a stand-alone basis, credit scoring is seriously flawed. It establishes a standard
that to some extent, assumes a homogeneity among small businesses which, in fact, does
not exist. Although there are certain common threads that identify small businesses, each
small company has its own distinct set of fingerprints. The question is not whether there
is enough capital available to finance small companies. There is. The real issue is
whether by using automated credit scoring systems this capital will reach those small
businesses, particularly start-ups, at a time when they most need it.

There is also a more fundamental issue that credit scoring does not address. By
its very nature, small business lending is highly personal and a very labor-intensive
activity for financial institutions. Unlike consumer loans or residential mortgages where
credit scoring measurements such as past payment records, job stability and income/debt
ratios provide a reasonable basis for approving loans, small businesses fall into a different



252



category. Once a car loan or a residential mortgage is granted, the transaction is
complete; not so with small business loans.

If there is one common thread that identifies most small companies, it is that they
are leveraged and very vulnerable to changes in the economy as well as to unanticipated
business events. Therein lies one of the problems of relying too heavily on credit scoring,
which tends to focus on loan generation but which is patently impersonal. Unless a
lending institution is prepared to engage in a continuing close working relationship with a
small business borrower, the approval of initial financing for a small company may, in
fact, prove to be a disservice to that company in the long run.

In one respect, the first loan to a borrower, supported by favorable credit-scoring
data, may be the easiest for a lender to grant and for a borrower to acquire. It is the
second request for financing that presents a potential clanger to the survival of small
companies, most of which experience some fairly dramatic financial buffeting during
their early years.

Small business lending is a multi-phase relationship. Most small companies need
more assistance than an initial loan. Each small company has a different level of
management sophistication and experience. They need help in tailoring loans that will
support their individual business plan. They need a loan officer who knows them
personally and understands their business. (See attached American Banker article).

During early stages of growth, most small companies encounter unanticipated
cash flow problems that require additional short-term financing. Those cash flow needs
often occur when balance sheets are seriously stretched. Unless a small business owner
has established a close personal relationship with his or her banker, their ability to secure
additional financial support may not exist. In short, credit scoring may provide the first
round of cash, but it is not designed to address the needs of small companies whose
circumstances are evolving.

There is no single answer to making credit available to small entities. It does not
make economic sense for large banking companies to dedicate the level of manpower
needed to work with small businesses on a one-on-one basis. Those larger institutions
justifiably will employ methods like credit-scoring to assist small businesses. The
turnover of lenders in most large banks precludes an extended close working relationship
between the borrower and a specific loan officer.

Community banks are best equipped to provide both the capital and other support
required by small companies. One objective should be to provide incentives for
community banks to increase their participation in small business lending by encouraging
bank regulators to establish separate standards for the evaluations and classification of
small business loans in a bank's portfolio. Those standards should reflect a tolerance for
bank support of young companies with leveraged balanced sheets which pose a somewhat
higher level of risk than more traditional loans. This is not to suggest that there be any



253

3



diminution in the level of bank documentation or supervision, but rather that regulators
be trained to understand the complicated nature of small business loans.

One of the most positive actions that Congress can take to assure the continuing
availability of credit to small companies is to support the Small Business
Administration's Loan Guarantee Program, particularly the 7 A Program. Banks like
Danvers Savings Bank, which are aggressive small business lenders, are able to provide
funding for many small companies because of the shared risk the S.B.A. programs offer.
Our ability to sell the guarantees in the secondary market allows us to control our asset
size, while re-cycling those same dollars into loans to other small companies. S.B.A.
guarantees also allow us to leverage our legal lending limit to a single borrower and thus
provide on-going support for successful growing companies. When Congress raises
questions about the future of the S.B.A., it casts a cloud and tends to discourage new
banks from participating in this valuable lending activity and it creates an atmosphere of
uncertainty in banks that already have made a significant investment in personnel and
systems to promote S.B.A. programs.

Our loan portfolio currently contains 209 S.B.A. loans and we have made many
other loans which have matured and been paid. In addition to the original SBA loans
which now are on our books, we have extended further non-guaranteed credit to over 35
percent of these borrowers which speaks to our confidence in these companies and
confirms the importance to the borrower of a close and on-going banking relationship.
Because of this extensive experience over a long period of time, we know the value of the
7A program in terms of job creation and can testify on the basis of first-hand knowledge
to the impressive success rate of scores of small, growing companies that have received
S.B.A. assistance when it really counted. As you continue to monitor this program,
which I truly believe is cost-efficient, it is important to keep in mind that the fee structure
not be raised to a point where the cost to an S.B.A. applicant becomes a disincentive.

In response to your third question, we would support efforts to retain the
disclosure rule as it pertains to loans made under 1 million dollars. Those disclosures
could provide a valuable tool in identifying the name, the size and the location of banks
engaged in small business lending. It may also provide a yardstick against which to
measure the relative contribution of large banks versus smaller community banks in this
important area of lending.

Sincerely,

James ^Zafns, J
^President

JGZ:mac

o



BOSTON PUBLIC LIBRARY



3 9999 06350 067



ISBN 0-16-053805-X




9 780160"538056



90000






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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 21 of 21)