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 8 of 21)
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has played and continues to play an increasingly important role in making "near
bankable" loans bankable. For the past three years we've been the #1 SBA bank
lender in Massachusetts and, most recently as of last year, the #1 SBA bank
lender for all of Southern New England.

In addition to the SBA, there are other state and local programs making a
difference for some companies. While no single program can fit each and every
need, there are now many options to consider. They can be tailored to help
businesses that are basically solid but with weaknesses that can be addressed
through the right credit enhancements.

Let me tell you a little about two of these programs. First, the Massachusetts
Capital Access Program shows how a state program can simplify borrowing for
small businesses that might not otherwise have access to credit. A few years
ago, Massachusetts created a $5 million reserve fund. CAP gives a participating
bank the ability to make loan decisions using its own underwriting standards,
but it also gives the community the opportunity to have loans go forward that
may be just below bank quality. We're proud that Bank of Boston was the #1
lender in this program last year.

Then there are the innovative microlending programs. The South Eastern
Economic Development Corporation (SEED) is an example that operates through
an intermediary at the community level. Working with another area bank, Bank
of Boston serves as the lead lender for a line of credit to SEED for microloans
below $25,000 that SEED makes directly to small business borrowers. Again,
lending under these programs has grown, not diminished, with the bank
mergers. I'd point out that we not only collaborate with intermediaries like
SEED; we also provide grant support because they provide a vital step-up for
the very smallest of businesses.


There are developments underway, including changes in credit policies, that
could further enhance credit availability. For example: a simpler one-page
credit application is now in use. We, as well as our competitors, have shortened
approval times as well. This simplified process has enabled customers to access
credit that they wouldn't have otherwise pursued because the previous process
was too burdensome.

And then there's the use of scoring for credit decisions. We're one of a small
group of banks that worked hard during the past 18 months to put together a
scoring system for small businesses applying for credit. It's worth pointing out
that the participating banks have tested our scoring system based on past credit
decisions and concluded that lending approval rates could very well go up with
this tool. In fact, Bank of Boston, using scoring, is seeing an increase in

While many banks like ours are using scoring, every application is still reviewed
on a "second look" basis by someone. If we can't make a loan because the score
is too low, we take the second look to see if there is someway to help make the
credit feasible.

Scoring may also help in the securitization of small business loans. If scoring
makes it possible to create a homogeneous portfolio that could be sold through
securitization, then there will be many more non-banks lending to small
business. For example, investment bankers aren't in this area of lending because
they can't tie up their capital. But if they could originate assets and treat them as
securities, we could see all kinds of non-banks getting into this business creating
more credit. Securitization has not yet taken off as a factor in small business
lending, but it will.

With regard to the delivery network for loans to small businesses, bank mergers,
in combination with improvements in technology and an increased focus on the
small business market, has created more not fewer channels. If you're a small
business, there are plenty of outlets to choose from— business development
officers in the field, loans by phone, PC banking, and branch offices. At Bank of
Boston, we have a far greater delivery network today than we had 5 or even 3
years ago.

In closing, let me reiterate that bank mergers can be good for small business.
With greater efficiencies and reduced costs, banks will be better positioned to
provide the small business segment of the marketplace with improved products,
faster delivery, and better access to credit. More and more, non-banks will come
to understand that this is a very profitable segment and banks will meet this
competition head-on. With more credit and delivery options available, the small
business customer will be a winner, not a loser, as a result of bank mergers.


llTi HEIL E Kertzman


One Exeter Plaza * Suite 200

Boston, MA 021 16-2831

PHONE 617/437-0600- Fax: 617/437-9686

Joyce L. Plotkin
Executive Director

* David Solomont

Busmen & Professional Sofw

•Mitchell E Kertzman

Powersoft CoTporauon

•Pamela DA. Reeve
lighthridge, Inc.
Vice President

•Mary E. Makela
MEM Associates

• Daniel S. Bricklin

^•tftware Garden

Karen E. Brothers
Inmagic, Inc.

•Richard A- Carpenter

Carpenter Associates

Statement of

David A. Blohm


Virtual Entertainment, Inc.

200 Highland Avenue

Needham, MA 02194

before the

Subcommittee on Taxation and Finance

and the

Subcommittee on Government Programs

of the

House Committee on Small Business

tnpUl I 'iitput Computer Sen

| i , ■.
PictureTel Corporation
Alain J. Hanover
\ nuL^i Systems, Inc



Field Hearing in
Boston, Massachusetts

Kija Kim

Harvard Design and Mapping Company , Inc

•Michael D. Kinkead

SandPomr Corporation

Michael E. Kolowich
Ziff-Davis Interactive
Raymond C. Kurzweil
k'ur;u'eii Applied Intelligence, Inc.
John B. Landry III
Lotus Development Corporation
Thomas M. Lemberg

Lotus Development Corporation

David C. Mahoney

Banyan Systems, ]nc

•Richard Rabins

Alpha Software CtyrporaOon

Morton H- Rosenthal
Corporate Software, Inc
A. David Tory
")pen Software Foundation

March 4, 1996

•Executive Committee


I am speaking on behalf of the Massachusetts Software Council. I am currently the Vice
President of the Council which is the trade association that represents the software
industry in Massachusetts. There are currently 1,948 software companies in this state
employing 97,700 people and generating $7.1 billion in revenue. Since 1989, we have
seen a doubling of the number of companies, revenue and jobs in the software industry in

My comments today are directed at the issue of financing of software companies,
including bank financing.

There are three primary types of financing of importance to software companies: start-up
capital, equipment financing and receivables financing.

Start-up capital is the key to new company formation and to the future of the software
industry. 77% of software companies nationwide are self financed — not by choice. Self
financing includes such methods as founders using their savings, using their home equity
lines, taking cash advances on credit cards and borrowing money from family and friends.
Banks do not lend money to start-up software companies because software companies
have little or no tangible assets that can be used as collateral. Banks tell the industry,
"Your assets walk out the door every evening."

In the 1980's self financing was significantly more viable than today. In the 1980's, the
cost of getting a first product to market was less, the market expectations on product
features were lower and the cost of sales and marketing was less. One could get to market
by spending between $50 - $200K.

Today, the cost of developing the first product and executing a marketing roll-out is rarely
accomplished for less than $1 million with more investment required to achieve company
profitability. Availability of start-up capital is, therefore, essential for new company

The most popular method for obtaining start-up capital is to seek venture capital or what
is known as "angel" financing from wealthy individuals.

Venture capital financing is accessible by only approximately 20% of software companies.
To get venture backing, a company needs to show a large potential market, a high growth
rate - 30% a year or higher and a high probability of generating a rate of return through an
EPO or sale within 3-5 years. The rest of the software industry, while having viable
smaller businesses, are shut out from this source of start-up and growth capital. These
companies comfortably generate sales in the $5-15 million revenue range. Formation of
these types of companies can result in significant job growth. The difficulty is finding
capital to get them started.

Going to the public markets for funding appears to be available only to approximately
10% of software companies and, ironically, is likely to be a viable option only at the point


in the company's growth and profitability when the need for capital to fund operations is
significantly diminished. A typical quandary facing Presidents of soon-to-be public
software companies is, "I can't invest the money I am about to raise in new programs
because if I do, it will affect earnings and lower our stock price." In a manufacturing
business, however, the money you raise can be used to finance additions to plant and
equipment in lieu of bank financing, with minimal impact on the bottom line.

As I have said, banks play no role in providing start-up capital for software companies.
They can, however, play an important role in financing equipment purchases. Computer
purchases represent a major cost and capital need in software companies. Banks have,
though, become extremely cautious when financing computers because of the rapid
obsolescence and, therefore, resale value, of the assets. Also, banks are reluctant to
finance computer purchases in what they perceive to be under capitalized start-ups.

I, personally, have been involved in three start-up software companies which have used
many of the types of financing I have mentioned.

The first company, Higher Order Software, was founded in 1977. I was the Chief
Financial Officer from 1978 to 1985. The company was financed at start-up by a DOD
contract. The result of the work under that contract created some technology that was
ultimately fundable by venture capital. In addition to venture capital and contracts, the
company used leasing companies to finance equipment purchases. Bank financing was
used to fund receivables.

The second company, MathSoft, I co-founded in 1985 and served as President. Initially,
venture capital was not available to MathSoft. We were seeking S500K. Alternatively, we
raised $150K from private individuals, "angels", and dropped our personal compensation
to very low levels. We used bank financing to purchase equipment but it required our
personal guarantee. Ultimately, we raised a total of $5.5 million of venture and private
money before going public in 1993.

My current company, Virtual Entertainment, is funded by one "angel" investor who has
invested approximately $3.8 million dollars. We are currently in the process of financing
equipment purchases with either leases or bank debt.

The bottom line, as far as the software industry is concerned, is that bank financing does
not play a role in new company formation. Even in Massachusetts, where the software
industry has worldwide recognition — banks are generally not participating in a meaningful
way to help this engine of growth for the Massachusetts economy.

Let me suggest three solutions which, although directly applicable to the software
industry, are generally appropriate for emerging markets

1. Tax advantages could be provided for investments made by "angel individual
investors" in early stage companies. These tax advantages could be applied to losses or


gains made on these investments or to investment level. These types of incentives would
lower the risk profile and increase the potential return of early stage investments. Similar
incentives could be provided to venture funds and flowed down to their limited partners.

2. Loan guarantees and tax advantages could be established to provide banks with
incentives to make loans to emerging companies for plant and equipment financing.

3. Programs could be established which set aside funds for early stage investment.
The Software Council was involved in one major effort to get funding from banks for
early-stage technology companies. We were instrumental in the passage of legislation to
allow for the creation of a small fund administered by the state's venture capital firm —
Massachusetts Technology Development Corporation. No state allocation of dollars was
made to this fund. Two major Boston banks each committed $1 million to this fund — but
not out of their corporate lending dollars, this money came from their community dollars.
And, since this is an investment, these banks will get back their money and a reasonable
return on their investment.


Statement of

Christopher C. Gallagher, Esq.

Gallagher, Callahan & Gartrell, P.A.

214 North Main Street

P.O. Box 1415

Concord, New Hampshire 03302-1415

before the

Subcommittee on Taxation and Finance

and the

Subcommittee on Government Programs

of the

House Committee on Small Business



Field Hearing in
Boston, Massachusetts

March 4, 1996


Mr. Chairman and Members of the Subcommittee. I am honored and
pleased to be invited to present my views on the issue of credit in the
wake of the area's "credit crunch", with emphasis on present bank credit
availability to small business in New England, particularly in light of
increasing mergers and consolidations now occurring in the banking

As indicated in a recent study conducted by Lisa K. Shapiro, Ph.D.,
for First NH Banks and the White House Conference on Small Business (an
Executive Summary of which is attached as Appendix I) , small business is
a vital component in New Hampshire's economy. Indeed it is undeniable
that "the business of New Hampshire," and of New England itself, is
small business. Downsizing, outsourcing, devolution to core-
competencies, and other structural contractions by large corporations
have resulted in layoffs, creating a need for even more small business
jobs. Accordingly, as we experience the effects of today's globally
competitive environment, small business continues to be the most
important source of jobs in our region. Indeed, for the foreseeable
future, small business may be the only remaining source of growth
available to complete our recovery.

Small business requires banking services and credit. Small
business jobs cannot expand unless the leverage afforded by banking
credit is also available. Moreover, as small business itself has moved
into global competition and markets, its financial service needs have
become more sophisticated. Accordingly, a robust local commercial
banking sector is critical to the principal engine of our region's
economic success.

Some small business concerns remain small by choice. Others are on
their way to becoming large businesses. Both require credit to invest
in new products and future growth. Both need access to competitively-
priced financial services in order to maintain efficiencies required to
grow while they stay competitive, and to participate themselves in the
new global economy. In New England, meeting the expanding demands of
small business is one of banking's largest challenges. The other is
gaining the operating efficiencies to do so. Indeed, one cannot
emphasize enough the critical interdependency of small business and
reliable banking services.

Area banks are robust, and are serving small business. To continue
this critical activity, they must be allowed by Congress and their
regulators to seek their most efficient operating structures, to choose
their optimal size, and to offer a product and service mix that suits
their markets. Small business customers need customized banking service
that is accessible locally but sophisticated enough to match its
competition anywhere in the world. To serve small business, banks must
have appropriate flexibility to match small business needs at a price
that will enable those customers to compete. Efficiency of operations
is the key to a strong competitive banking system. That efficiency
requires that each bank do what it knows it can do best. Banks serving
small business must maximize their own operating, structural and cost
efficiencies. Indeed, safety and soundness in a fiercely competitive
environment require that banks be allowed and encouraged to operate more
efficiently. Measures that enable banks to perform efficiently are a
benefit to small business.


Consolidations and mergers are tools banks employ to create and
maintain operating, service and product efficiencies. Such
restructurings provide the facility appropriate for the competitive
delivery of quality financial products and services to small business.
Temporary displacements and disruptions caused by consolidation are
regrettable. They should be minimized and mitigated wherever possible.
The recently announced merger between Citizens Bank and First NH Bank
featured the establishment of a public/private partnership between the
bank and New Hampshire's Department of Resources and Economic
Development (DRED) . DRED Commissioner William Bartlett has praised this
5-Point Program for retraining and reemployment of displaced employees
as "forward-looking and very beneficial to a state that is attracting
new business and needs qualified employees". Dealing directly with
employee impacts rather than resisting consolidation is the direction in
which we must move. Consolidations that increase bank efficiency must be
encouraged if commercial banks are to continue to play their vital role
for small business in our New England economy.

It is appropriate in this regard to comment on the continuing
impact of FDICIA (Federal Deposit Insurance Corporation Improvement Act
of 1991.) FDICIA was a part of Congress' response to lending excesses
that led to the credit crunch. In retrospect, FDICIA has contributed to
the recovery of our nation's and our area's banking sector. Its timing
was difficult for New England, but its objectives are now taking hold.
FDICIA has succeeded in forcing banks to raise capital. That capital
has provided a firm cushion, enabling banks to extend more credit to
small business. Small business lending often carries with it a higher
level of underwriting risk because of reduced information in the areas
of reliability, profitability, and the general uncertainties associated
with am business venture at the start-up stage. Added capital thus
enhances, the small business underwriting process.

New England's recovery has been driven, of course, by lower
interest rates, but not by interest rates alone. Gradual and sensible
regulatory application of FDICIA' s more restrictive provisions has
played an important role. Congress itself has now taken positive steps
towards reduction of excess regulatory burden on banks. Moreover, led
by Comptroller Eugene Ludwig, constructive regulatory reform has been
undertaken within the bank regulatory agencies themselves. Efforts to
streamline the regulation process, making it more efficient, more
realistic and more reliable, have enabled banks and bank regulators to
become more efficient. State regulators, increasingly concerned about
potential conversion by state banks to federal charters, are following
suit, addressing inefficiencies in their own regulatory processes.

These developments have enabled banks to become more competitive
with their less-regulated brethren in the world of financial services
without the sacrifice of safety and soundness. Indeed it is
increasingly clear that the efficiencies afforded by revised regulation
are themselves a contributor to enhanced safety and soundness. These
trends must continue because they lead to more bank lending and better
bank services for small business.


There also remains a continuing need to monitor any adverse and
unintended impacts of FDICIA that, as technology improves, could cause
unnecessary operational inefficiencies. Just as increased efficiency of
operations leads to more banking for small business, such inefficiencies
could lead to a withdrawal of credit from small business in any future
cyclical downturn. For now, however, regulatory emphasis on raising
capital while reducing needless process has allowed banks to improve
their operating margins without having to accept unsound portfolio risks
pursuing rates of return based upon higher risk. New efficiencies have
enabled them to compete with other more efficient and less-capitalized
competitors that match in every market their menu of financial services
and products. Banks have thus been able to take sound risks and still
show a solid return on investment. This bodes well for small business.

We have been stressing the direct connection between the
operational efficiencies of banks and their benefit to small business.
It is important to focus briefly on why banking efficiencies are
critical to bank survival in the highly competitive world of financial
intermediaries and capital markets. After all, survival of today's
banking system is critical to the continued strength of our small
business sector. Speaking in terms of "survival" is not hyperbole.
With the author's permission, I have attached (as Appendix II) a short
treatise on today's banking markets by Alex J. Pollock, President and
CEO of Federal Home Loan Bank of Chicago. This well-written article
defies adequate summary. Its succinct explanation of the relationships
between efficiency, consolidation and developing markets in banking
shows why consolidation in banking is both inevitable and necessary.

Quoted below are its first two paragraphs, followed by a sentence
appearing later, concerning consolidation.

The efficiency of the financial system's intermediation, how well it
is doing for the consumers of financial services, is measured by the total
spread between what the ultimate investor gets as a yield on savings and what
the ultimate entity being financed has to pay. The less the financial system
takes out of the middle, the more efficient it is.

The financial system designed in the 1930 's created large spreads, for
example between holders of passbook savings on one hand, and corporate
borrowers at prime rate or more, plus fifteen percent compensating balances
(as it used to be), on the other hand. The financial evolution of the last
two decades, shrinking the aggregate spread to intermediation, has
continually reduced the role of the 1930 's design, and makes it impossible to
support its former overhead structures. (Appendix II, Page 1)

. . .As the system becomes more efficient, there is accordingly excess
capacity which should leave and be utilized elsewhere. Therefore, the shift
away from clubs and club managers naturally protective of their members,
toward market systems, means consolidation. (Appendix II, Page 2)

Mr. Pollock's explanation of the efficiency dynamic in modern
financial services markets is compelling. It leads to the inexorable
conclusion that consolidation in banking must continue. It compels the
conclusion that other operating efficiencies which do not detract from
safety and soundness must also be encouraged. Accordingly, since banks
are the most common and the predominant source of capital and qther


financial services needed by small business, it is clear that enabling
banks to achieve the efficiencies needed to thrive is beneficial to
small business.

In a related important development, it appears that Congressional
action on Glass-Steagall reform may not occur, or if it does, may not
provide structural efficiencies appropriate for small institutions.
Securities "push-out" clauses, and other structural impacts requiring
more cumbersome operations through affiliates, raise efficiency concerns
for medium-sized banks and serious operational problems for smaller
banks. Prohibitions affecting the providing of basic financial services
and products can reduce the core deposits that predicate local business
lending. Smaller banks that are themselves, "small business"
organizations, view these legislative initiatives with some alarm,
fearing that they will be unable to stay small and stay strong at the

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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 8 of 21)