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 3 of 21)
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panies that are their borrowers.



15

However, I would be quick to point out that not all small commu-
nity banks have the talent or the stomach for a specialized lending
function that involves more than the usual amount of risk.

Having said this, I should also comment that from personal ob-
servation, it appears, as Lincoln just said, that a growing number
of community banks are beginning to engage in small business
lending as a means of acquiring interest-sensitive assets and reduc-
ing their interest rate risk. That's a positive sign for small busi-
ness.

During the past few years, my bank, Danvers Savings Bank, has
focused on small business lending. We were the first mutual sav-
ings bank in the country to be designated a preferred lender by the
Small Business Administration.

Our asset size is approximately $235 million, a relatively small
bank. But we have extended credit of almost $50 million to 263
Massachusetts companies under the SBA loan guarantee program.
Although I do not have an exact count, I would say it would be a
conservative estimate to say these companies provide at least 3,000
jobs.

There is no magic in what our bank does. Early on, we made a
commitment to small business lending, and we invested in the peo-
ple and delivery systems needed to make it work. Other community
banks have done the same thing. As I have stated, there is increas-
ing evidence that more community banks are beginning to see the
profit potential of working with small companies.

The SBA loan guarantee program has been a critical element in
our success. It has reduced the inherent risk in a small business
loan portfolio, allowed us to generate fee income and control our
asset size through secondary market sales of guarantees, and that
in turn has allowed us to recycle those same dollars by making
loans to other small companies. I should add that the delinquency
rate of our SBA loan portfolio is no greater than that of our conven-
tional commercial loan portfolio.

In summary, as banks merge and increase in size, they become
more remote from small business customers and less able to pro-
vide the close working relationship that most small companies re-
quire. Community banks will continue to serve as the primary
source of loans for growing businesses. The SBA loan guarantee
program, particularly the 7(a) Program, is a vital tool for commu-
nity banks in their small business lending efforts.

I would urge your Subcommittee in its deliberations to continue
its support of the Small Business Administration as the most cost-
effective way to use to guarantee the Federal Government to create
well-paying jobs in our market sector.

Thank you.

[Mr. Zafris' statement may be found in the appendix.]

Chairwoman Smith. Thank you, panelists. I will take the prerog-
ative of the chair for the first question. We are not going to be
quite as tight on questions, but if you could keep your answers
brief, we'll try to make our questions brief so that we can cover a
lot of areas.

First of all, when this was brought to me, the issue of a character
loan was the concern, that as consolidations started, the character
loan would be a thing of the past, and there would not be anyone



16

meeting that character loan for the small innovations that have
made America great — an idea that you need someone to help back
you.

I will tell you what my experience in my State has been — and I
was concerned there, but now we do have additional banks form-
ing. We have had 30 new ones form to fill that need. In my part
of the Nation, there doesn't seem to be any problem at this point
that is extensive, but it appears here that you have the character
loan issue.

You were addressing that the key is still the local bank. The lo-
cality of that means that you and I go to the rotary together. You
know that I've never had a business that has failed. This is an in-
novation I've got for you that is maybe a higher risk if you didn't
know Linda Smith and that I don't fail. You would give a loan to
me because I'm a good risk, but you wouldn't know me from Adam.

Are you feeling in this region that because you have such big
banks that there is a need for that, or do we just need to wait? If
we wait, are those innovations stifled and do they have to go to
higher levels of risk themselves, which means that some of us that
have innovations will not at a certain point risk the other assets
we have?

Briefly, not everyone needs to address that, but, talk to me about
the character loan. Can we wait? Have we closed out a certain mar-
ket? If so, what would you say we would need to do? Mr. Galla-
gher?

Mr. GALLAGHER. Well, thank you for that question, because that
really is the issue. If we translate the character loan into the terms
of the Information Age, they would call it a low information loan
and one that's not exportable easily to markets that look for that
kind of predictability.

Smaller banks use these community relationship techniques. It's
not only that they know Ms. Smith, but they know the place where
her business is going to start. They know what that market is.
They bring those factors to bear. It's a personal relationship type
lending that we have got to keep if we want to keep America mov-
ing the way it has been moving. If we want innovation, if we want
creativity, that kind of lending nas to be made.

That kind of lending is typically made by smaller banks, and
that's why smaller banks are to me so important and so critical to
the way we distribute capital in this country and to the innovation
that is needed. Larger banks have found other ways to do it. Credit
scoring is a way to do it. It does work. It's highly predictable. It's
tied to the actual evidence of the character of the borrower, and it
works. It can be very efficient.

The really low-cost loans are more likely to be made by larger
banks using credit scoring than they are oy smaller banks using
their relationship personal knowledge. But the fact is, we need
both and we need to preserve both, because there are pressures
within the market that want to simply bypass the inefficiencies
built into the banking structure and provide business capital only
to those businesses that are so uninnovative that they are abso-
lutely predictable.

In short, Ms. Smith and Chris Gallagher could start a Mac-
Donalds, but we couldn't start our own restaurant, even though we



17

knew and our banker knew in that town that that would work and
what a great bartender you were and what a great cook I was or
whatever it was that made it happen. That kind of innovation has
to remain if we're going to have the innovation in business and cre-
ativity that we need to come out of the economic doldrums that we
experience.

Chairwoman SMITH. Can we, though, wait and see is the ques-
tion. Whether or not we'll keep those local community banks or
whether the consolidations are going to — it takes me a lot more
time to rate a personal loan than it does to put up a score. I'm wor-
ried the competition could come in.

Mr. Hamill. I guess I would comment that I think what's being
set up is a black and white situation, and it's not that easy. Even
in the largest of the banks such as Fleet, we have the ability to
handle loans under $50,000 in the format that I described, through
the credit scoring process. The approval rate has been 70 percent,
which has been about the approval rating that had been in place
from the bank before that process was put in place.

Second, I would make the point that there are over 100 Fleet
people who are dedicated to being out in the marketplaces to make
small business loans. This is not just about calling a 1-800 num-
ber. Third, the Fleet people are in the local marketplace and there-
fore, a person who wants to come in and talk to them can also come
do so.

Last, I would say that the issue ultimately is not just character.
While that's important, it's also the ability to repay as was men-
tioned earlier.

The larger bank has larger amounts of capital to be able to ab-
sorb that risk. A smaller bank has a more limited amount of cap-
ital, and, therefore, has a more difficult time absorbing risk. So, I
think the answer is somewhat complex and is not just about the
character loan.

Chairwoman Smith. Thank you.

Mr. Morison. Can I sort of jump in?

Chairwoman Smith. Yes. Mr. Morison?

Mr. Morison. To me, the character loan is more myth than it
has been reality. The day of an individual walking into a bank,
shaking hands, walking out with $50,000 with a note to be signed
later, with no collateral, no financial information, if it ever existed,
didn't exist in very great quantity.

You have to keep in mind that banks are not lending their own
money. Banks are lending depositors' money. They're lending
shareholders' money. The tolerance for risk in a financial institu-
tion is extremely small. Most well-managed banks are earning
somewhere between 1 and IV2 percent on assets. If you run
through the math, you'll find that the tolerance for error in lending
in any financial institution is extremely small.

You'll also find that the size of the legal code has expanded at
a compound rate far faster than anything else has grown in this
country, and the legal system itself makes it very difficult to lend
on informal terms and conditions.

Character, as John Hamill has stated, is, in fact, the first issue
that a bank addresses in making a loan, as to whether the person
with whom you're dealing is a person of integrity, is a person of



18

capacity, is a person who has a track record of living up to his/her
commitments. That element in the lending process will never dis-
appear.

We are finding ways to mitigate risk without having information.
As a matter of fact, the large banks have been very innovative in
using personal credit histories of the principals as a substitute
lending criteria to small businesses rather than extensive financial
information from the business itself.

But in the last analysis, the ability of a financial institution to
make a loan depends on the ability 01 that institution to assess not
just the willingness to repay. Every borrower that we come in con-
tact with wants to repay that loan. The issue is whether he or she
can repay the loan. Capacity is something that is determined
through information as well as through collateral.

So, I think we have to be careful when we mythologize the char-
acter loan into something that it never really was. As was pointed
out, it is the ability to take risk without perfect information. There
are a variety of inputs that one uses to do that.

I think I could make the case that big banks in their own way
are finding ways to do that, as are small banks. We simply choose
to do it face-to-face. They are finding other mechanisms to achieve
the same result.

Chairwoman Smith. Thank you.

Mr. Zafris?

Mr. Zafris. I think we all agree that there is enough capital out
there to fund small business. The real issue is whether that capital
is being channeled to the small businesses that need it. I perhaps
will take a somewhat contrary position to other members of the
panel on that score.

I sort of have an old-fashioned way of defining banks, and I think
there are banks that take the position of, "How can we do the deal?
How can we make the loan?" as opposed to, "Why should we make
the loan?" There's a very wide difference between those two phi-
losophies.

I think that's why we're seeing a diversity of banking charters
of small businesses. Men in the communities are iust saying to
themselves, "If we can't get the credit somewhere else, well start
our own bank to make it easier for us to get the credit to those
startup and young and growing companies."

Let me give you an example. I had lunch on Wednesday with the
President of a software company to whom we paid an SBA loan 4
years ago. That company was referred to us out of our county but
not too far from our bank, probably 30 miles away. That company
was referred to us only after they had been turned down by a large
bank.

While we were having lunch on Wednesday and he was sort of
bringing me up to date on how the company was doing and part
of what he told me — and obviously, we have been following the
company pretty closely — is they did $18.5 million in sales last year.
They have 200 employees currently working, all at high-paying en-
gineering type jobs. They expect to do $25 million in sales this
year.

They'll be closing on their first private placement of $5 million
this week, and they anticipate that they'll be doing as much as



19

$100 million in 1997. I mentioned to Congressman Meehan that he
might like to visit that company. It happens to be in his district.

But when we were concluding the luncheon, the President said
to me, "when we came in to see you to get that first loan, I knew
you really didn't understand exactly what we were doing, but you
bet on us." I didn't think I was making a character loan, but I
thought I was making a judgment call in terms of what kind of
people we were dealing with, what their experiences had been, and
what they were bringing to the table.

By using an SBA loan guarantee to sort of soften the risk that
I was taking, it seemed to me to be a prudent risk. I think that
smaller community banks are much more willing to take the time
and to give the kind of personal service that you need to give to
companies like that that have enormous potential for growing the
economy and providing jobs.

One of the complaints that I frequently hear from people who
will be referred from other banks is that there is a massive loan
officer turnover in the larger banks. It's just the nature of the insti-
tution. There is not much incentive for a young MBA graduate at
a large bank who's just trying to build his reputation to take risks
with small companies that may not succeed.

There is a tendency to say, "Why should I do it?" rather than,
"How can I do it?" So that while I think that I would agree with
Mr. Morison that the character loan also has a number of different
definitions, I think personal banking, personal attention to small
business borrowers is essential if we're going to help those small
companies grow and prosper.

Chairwoman SMITH. Thank you.

Mr. Meehan, would you like to take the next question?

Mr. Meehan. Yes. I guess we're all a product of our experiences.
I remember when I graduated from law school, which really wasn't
that long ago, and represented a number of small businesses, I re-
member taking in a plumber who had his own business into a
small bank and loan, and we sat down and he filled out what he
needed to fill out. The bank president interviewed him.

Within a matter of a few months, we went back, and he got a
$150,000 loan. They evaluated his financials, and they had done a
pretty thorough job. I thought pretty quickly, the loan was avail-
able. We were talking during the closing to the bank president
about how that got done so quickly.

The bank president said, "when you came in here, I could tell
just from talking to you that your hands, for example," he said,
"were dirty. I have a lot of plumbers that come in here in suits,
and I wonder who the heck is doing the work." And he said, "When
you talked about what you had to do and what you're going to do
later on, I made an assessment during the IV2 hours or so that you
were here."

I think when we talk about character loans, to me, that's — I
mean, I listened to this banker talk about how he evaluates in ad-
dition to all the financials, how he evaluated this particular indi-
vidual that came in who was an extremely hard worker, someone
that as Congresswoman Smith said, somebody who doesn't fail. I
mean, they just are committed.



20

So, I think that's what we're talking about when we talk about
those kinds of character loans. I recognize the legal obstacles to
making loans, the fact that there's excessive regulation oftentimes,
and particularly in small banks, almost an incentive to prevent
banks from making loans.

But I want to ask, all of us, I think, can agree that banks and
small business is the key to economic growth. There's a serious
concern that many of us have that bank consolidation leads to
fewer loans. If that were true, then that's certainly a situation that
would undermine the economy.

In Massachusetts, for example, we have lost in excess of 30 per-
cent of our banks over the last 5 years due to closures and consoli-
dations. But it's impossible — and I'm also aware of the conflicting
aspects of the study that was done by the Federal Reserve Bank
in Boston and the study that was done in New York.

But it's impossible to address these concerns of Congress unless
we have all the necessary facts and figures to try to determine
whether or not this consolidation is having a negative impact or
not. I feel strongly that the 1993 Small Business Loan Disclosure
Rule that requires banks to report yearly all loans under a million
dollars is an indispensable tool in this effort for Members of Con-
gress to stay informed, yet many banks, both large and small, have
lobbied Congress to eliminate this provision as part of a banking
regulatory reform package.

I guess my question is to all of you, is this something that you
want to see repealed? If so, could you explain to me why, since it
clearly helps the Government and Members of Congress track
small business lending in order to make an evaluation of what
works and what doesn't work and whether or not there has, in fact,
been fewer loans? This seems to be one effective tool for us to do
that. So, I was wondering if all of you would comment on that.

Mr. Morison. I would love to get rid of that.

Mr. Meehan. I'm well aware of that. I'm watching the bill.

Mr. Morison. The reason is that The First National Bank of
Ipswch is a $100 million dollar bank. Our legal limit is $1 million.
Our house portfolio limit prefers loans in the $500,000 to $750,000
range just to get risk dispersion in the portfolio. In fact, our aver-
age loan is probably closer to $100,000 or $150,000.

In the Call Report, I distinguish between consumer loans and
commercial and industrial loans. So, almost by definition, every
loan I make that is a commercial and industrial loan is a loan to
a small business, because I haven't got the resources to lend to
anything other than a small business.

So, for me, the reporting, I think, is superfluous. That would
apply to banks, I think, that are larger than $100 million by some
amount.

Mr. Meehan. How about the larger banks?

Mr. ALOISE. I think I would have to concur with Lin Morrison
that I don't really find that regulation very helpful. I'm not sure
it really helps you really get a handle on credit availability in the
marketplace. Particularly with a bank like Bank of Boston, where
we have both local and national lending responsibilities, I'm not
sure that that tells you very much.



21

Mr. Meehan. Doesn't it at least tell us how many loans that the
Bank of Boston made?

Mr. Aloise. Well, it might say, "This is how many loans have
been made." I don't think it would be fair to use that yardstick to
see how effective we were. In fact, it's looking at things like our
CRA performance and other things like that and the amount of
credit being made available to specific marketplaces which may be
more important than just how many of those aggregate loans were
made.

But beside that, besides this reporting, we have our own yard-
sticks. We have our own obligations and goals to put money into
the marketplace. Quite frankly, as one bank that has a stated pol-
icy of achieving an outstanding CRA rating, I would forecast that
to live up to that, particularly under the new regulations, by defini-
tion suggest you have to be very aggressive in the marketplace for
small business.

So, I'm not sure that the current laws really give everyone what
they think they need in terms of measuring. I'm not necessarily for
it. I'm with Lin. On the other hand, I don't let it drive me or drive
our bank's performance.

Mr. Hamill. We have been telling the story of how many small
business loans that we make. Anything that would help to tell that
story further, I'm in favor of. I think that the reasons people are
against it, are paperwork and reporting burdens.

I think what people forget in this process is that it's sort of like
what Senator Dole said yesterday: "I wasn't born Senate majority
leader." He said, "I started someplace else." The big banks of today
weren't born big. We are an amalgamation of small banks that got
to be good because of the fact that we served the local communities.

There is a feeling, therefore, that all of a sudden, these banks
that were built up that way are going to transform themselves into
something different. That's not true. We can't transform ourselves
into something different, because we are what we have been. You
don't overnight change yourself. If you even wanted to, you couldn't
change yourself.

I think that what we have here is a notion that big banks
couldn't possibly be involved in small business lending. You ve even
heard one of the panelists say that big banks really wouldn't want
to be small business lenders.

Yet, as the first regional preferred lender, Fleet has made $140
million in SBA loans, making all the kinds of loans to those small
businesses that really need the loans. I would say that I would be
willing to give you anything, Congressman Meehan, that would
show you what it is that we're doing in order to take care of the
regional issue that you're trying to address, and to make sure
you're comfortable with it.

I'm not sure a Federal reporting disclosure form is the best way
to do it. Discussions like this, pieces of paper that would show you
where we make the loans so that you're comfortable with it and
you can talk to your constituents, I think, is really a better way
to go.

Mr. Gallagher. Congressman, I would like to take your ques-
tion, which I think is a very good one, and sort of lift it out a little
bit and give a different perspective. What you're hearing from



22

smaller banks is, "We can't live with much more of this regulation."
And what you're hearing from larger banks is, "We can."

In a very real sense, the pile-up of regulations upon banks is
driving the issue of consolidation, because it's an efficiency issue.
If efficiency becomes hampered by too much regulation, then you
have a problem of operating as a small bank, and you have to be
larger.

Now, at the same time, you folks in Congress and the regulators
have to have data to work with so that they can watch it. So, you
wind up with this weird anomaly, we have got to kill this village
in order to save it. That's what we need to get away from.

There are legislative initiatives in Congress today that will bene-
fit, in the same way, larger banks who can stand, because of their
size, the operating inefficiencies of fire walls and affiliates and all
the rest of it, but will kill smaller banks who won't be able to at-
tract the deposits and the liabilities they need in order to compete
effectively.

I think it's important that we keep both kinds of banks operat-
ing. They each perform a service. They do valuable things. They
each have a different view, and you can hear those different views
on this panel. It's important that that competition be kept alive. I
think it will not be kept alive until and unless the regulators and
the Congress understand that too much information for them may
mean too much inefficiency for us smaller banks.

Mr. Meehan. Maybe we're in a situation where smaller banks
should have a different kind of regulatory scheme. I hear that all
the time.

Mr. Gallagher. That has been reflected in CRA. It has been re-
flected in the streamlined exams that the Office of the Comptroller
of the Currency is doing. Eugene Ludwig is actually addressing
this and doing a good job. But there's a lot of folks in Washington
who aren't very happy about that, because they think Congress

Mr. Hamill. But I think defining the question — because I think
what you're hearing is the allegation that big banks do want to
make small loans. That is just not true. We have the numbers to
show that, and we're committed to it, because it's a big part of our
business. We make money at it. We like the business. We have in-
vested millions and millions of dollars in people and systems.

It's that gray area that we're talking about. It's that company
that is struggling to get to the next tier; that is, that it needs a
little more money. It has a good idea and could be the next Digital


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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 3 of 21)