Why is the FDIC undercounting community bank small-business loans?

The FDIC has found that community bank small-business loans are being undercounted.

By Chris Cole

Community banks are even more prolific small-business lenders than previously thought. That’s the conclusion of a forthcoming FDIC study that found the agency has been significantly undercounting community bank small-business loans.

In a wide-ranging survey previewed at November’s FDIC Advisory Committee on Community Banking meeting and scheduled for release this year, the FDIC questioned more than 1,000 community banks and conducted follow-up discussions with 51 of them. The agency concluded that small-business lending by those institutions was undercounted by at least $38 billion in the fourth quarter of 2015.

Demanding a recount
Why were the FDIC’s numbers so far off? It has to do with how the agency calculates small-business lending. Traditionally, the FDIC has simply totaled the commercial and industrial loans of less than $1 million that community banks submit in their quarterly call reports. In the fourth quarter of 2015, banks with less than $10 billion in assets made $118 billion in C&I loans.

In conducting its 2016 Small Business Lending Survey with the U.S. Census Bureau, however, the FDIC discovered that this definition was insufficient. For one, the agency found that many of the community bank loans secured by one- to four-family residential properties are utilized by small businesses. This added $16 billion to the FDIC’s total for the fourth quarter of 2015.

That’s not all. The FDIC also found that community banks often make loans of more than $1 million to small businesses with less than $1 million in annual revenue. In fact, community banks with between $1 billion and $10 billion in assets said 20 percent of their C&I loans to small businesses topped $1 million. Because loans to small businesses with less than $1 billion in annual revenue should be considered as small-business lending, this would cumulatively add another $21 billion to the fourth-quarter 2015 count.

What about community banks under $1 billion in assets? Unfortunately, the FDIC doesn’t have that data broken out, but it used information it does have to make a conservative estimate. According to existing data, 86 percent of banks with less than $250 million in assets and 77 percent of banks between $250 million and $1 billion said that, largely, their C&I loans were made to small businesses. Assuming this is true for half of all C&I loans of more than $1 million made by community banks under $1 billion, the FDIC added another $93 million to its loan total.

Lending leaders
It all adds up to $38 billion in uncounted small-business loans for the fourth quarter of 2015. The FDIC rightly concluded that relying solely on call report proxy understates community bank small-business lending. The agency’s data-collection adjustments promise to provide a fuller and more accurate picture of community bank small-business lending now and into the future.

The FDIC’s updated scoring system for community bank lending wasn’t the only takeaway from its 2016 Small Business Lending Survey. The survey also offers a comprehensive look at how community banks use their local focus and personal relationships to continue leading the industry in small-business lending.
While large banks standardize, community banks customize. The report found that community banks are much less likely to use standardized small-business loan products (9 percent) than larger institutions (65 percent). They’re also less likely than their larger competitors to use thresholds to define small businesses (28 percent to 85 percent) or to use minimum loan amounts (15 percent to 70 percent).

Further, banks large and small recognize the advantage of the community bank personal touch. The survey found that 58 percent of smaller institutions said they have a competitive advantage over larger institutions in providing personal attention, while 49 percent said their decision speed gives them an edge. In gauging the advantages of their top bank competitor under $1 billion in assets, community banks cited relationships (57 percent), personal attention (36 percent), decision speed (28 percent), location convenience (27 percent), loan structure flexibility (24 percent) and interest rates (20 percent).

Larger institutions acknowledged the benefits of community banking, too. According to the survey, 67 percent of large banks said the primary competitive advantage of their top competitor between $1 billion and $10 billion in assets is loan structure flexibility. Another 41 percent cited more competitive interest rates.
Community banks also serve small businesses at their earliest stages and often outside of large metropolitan areas. The survey found that roughly 80 percent of community banks lend to startups (defined as small businesses less than two years old). Of these, 74 percent are in metropolitan statistical areas and 85 percent are outside these more densely populated regions.

Meanwhile, community banks do it all while retaining a culture of safety and soundness grounded in traditional underwriting criteria. The survey found that 95 percent of community banks said they always or almost always consider loan debt service coverage for their top loan product. Meanwhile, 94 percent used loan-to-value ratios, 92 percent took the owner’s net worth into account, 85 percent used a personal guarantee and 85 percent considered the owner’s experience.

In Washington and across the nation, community banks are regarded as the financial services industry’s premier small-business lenders. This new FDIC report—which will only bolster our standing and continued case for meaningful regulatory relief—shows that the industry is even more deserving of its sterling reputation than anyone realized.

Chris Cole (chris.cole@icba.org) is ICBA executive vice president and senior regulatory counsel.