CREDIT, BANKS AND SMALL BUSINESS THE NEW CENTURY. January Jonathan A. Scott. William C. Dunkelberg. William J. Dennis, Jr.

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1 CREDIT, BANKS AND SMALL BUSINESS THE NEW CENTURY January 2003 Jonathan A. Scott William C. Dunkelberg William J. Dennis, Jr.

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4 CREDIT, BANKS AND SMALL BUSINESS THE NEW CENTURY Jonathan A. Scott, Temple University William C. Dunkelberg, Temple University William J. Dennis, Jr., NFIB Research Foundation

5 1201 F Street NW Suite 200 Washington, DC nfib.com

6 TABLE OF CONTENTS Foreword List of Tables Executive Summary Credit, Banks, and Small Business The New Century Methodology Highlights of Financial Service Experiences Mergers and Competition Mergers, Competition and Service Quality Competition and Credit Quality Sources of Financing for Small Firms Types of Financing Credit Card Use Trade Credit Use Product Use and Service Assessments Product Use Technology and Product/Service Use Service and Relationships Credit Availability and Terms Credit Search Success in Obtaining Credit Terms of Credit Price of Credit Conclusion Appendix I: Credit, Banks, and Small Business Survey Appendix II: Total Sample Response Distributions

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8 FORWARD The climate for financing small businesses has changed radically since this series began to document it over two decades ago. Most of the changes have been for the better. Credit availability now is greater; interest rates are lower; new classes of lenders are entering the market; financial service providers are more likely to focus on small business and more intense competition exists for its financial business; and, relevant financial services, many of them new, are abundant and their numbers growing. However, all changes have not been favorable. The positives have been accompanied by some negatives. The most notable downside has been the turbulence and instability associated with bank mergers and acquisitions as well as the growing impersonality associated with the greater use of technology in the financial services industry. Nor, have rising fees been popular. Many of these changes resulted from deregulation of financial services beginning in the late 1970s, accelerating into the 1980s, and carrying through to the present. Other changes have resulted from fluctuating economic conditions. It is now difficult to imagine that when NFIB began documenting small business financing conditions the prime interest rate reached 20 percent. It is not important here to sort out the relative contribution of each of these factors to the general improvement in small business financing conditions over the last several years. It is only important to recognize that these changes occurred and that both contributed. This edition is the sixth in the Credit, Banks, and Small Business series. The first survey for the series was conducted in 1980, followed by others in 1982, 1984, 1987, 1995, and in the late autumn of This constitutes the longest time series on small business finance known to the authors, and indeed the only one available except the shorter-running Survey of Small Business Finances produced by the Federal Reserve. The latter dates to While there is some overlap in content between these two perspectives on small business finance, they are on the whole complementary to one another. NFIB devotes more attention to market conditions such as the impact of mergers and competition, and small-business owner demand/satisfaction with banking services while the Fed collects more detailed information on the use of credit and credit-type products. From the beginning, the survey sample for Credit, Banks has been drawn from the NFIB membership. The 2001 version is the same. While the NFIB membership is large and generally reflects the broader population, the sample inevitably creates questions about representativeness. The authors discussed weighting the data in response. A decision was made NOT to do so. The rationale for the decision was that the primary interest of the series is in trends (over time). If weighting were important, the revised data would not allow comparisons among 1 Credit, Banks and Small Business The New Century

9 points in time. If it were not important, there would be no need to weight. Thus, the data appearing in this publication are comparable to prior series editions. The Credit, Banks micro-data are available for researchers wishing to use them. A set of weights appears in the data set for those more concerned about representativeness and less about change over time. The weights were created by the authors from a three-axis matrix consisting of employee size of business (4 classifications), industry (8 major SIC codes), and geographic region (7 regions). The matrix was produced by the Office of Advocacy at the U.S. Small Business Administration using 1997 Census data. The NFIB Research Foundation hopes this edition of Credit, Banks, and Small Business will provide greater insight into small-business financing, one of the most important and discussed aspects of small business ownership and operation. NFIB Research Foundation January, Credit, Banks and Small Business The New Century

10 LIST OF TABLES Table 1: Survey Respondents by Selected Demographic Characteristics Table 2: Selected Financial Service Experience 2001, 1995, and Table 3: Bank Size by Selected Financial Service Experience Table 4: Experience with Bank Mergers and Acquisitions 2001 and Table 5: Change in Competition for Banking Business Over Time Table 6: Bank Mergers and Competition 2001 and Table 7: Effect of Bank Mergers and Competition on Service Quality Table 8: Effect of Bank Mergers and Competition on Fees and Credit Availability...16 Table 9: Competition for Banking Business by Selected Firm Characteristics Table 10: Distribution of Financing Sources 2001 and Table 11: Sources of Funds for Working Capital by Selected Firm Characteristics...20 Table 12: Sources of Funds for Capital Outlays by Selected Firm Characteristics Table 13: Sources of Financing by Selected Firm Characteristics Table 14: Financing Patterns and Source Combinations Table 15: Patterns of Credit Card Use Table 16: Credit Card Use by Selected Firm Characteristics Table 17: Patterns of Trade Credit Use Table 18: Trade Credit Discounts by Selected Firm Characteristics Table 19: Financial Service Use by Selected Firm Characteristics Table 20: Internet Banking by Selected Bank and Firm Characteristics Table 21: Preferences for and Delivery of Selected Attributes of Financial Institutions Table 22: Conditional Top Performance by Selected Market Characteristics Table 23: Conditional Top Performance by Selected Firm Characteristics Table 24: Loan Application Experience Table 25: Non-Borrowers by Selected Firm Characteristics Table 26: Loan Application Activity Table 27: Loan Search Outcome 2001, 1995, and Table 28: Loan Turndowns by Selected Application and Firm Characteristics Table 29: Loan Size, Type, and Non-Price Terms for New Loans Received Table 30: Collateral and Other Loan Requirements by Selected Firm Characteristics...59 Table 31: Rate Paid on Most Recent Loan Appendix: Total Sample Response Distributions Credit, Banks and Small Business The New Century

11 EXECUTIVE SUMMARY Among America s small-business owners, banks remained the primary source of external funding for working capital and capital expenditures. However, the importance of banks as a source of funds declined modestly between 1995 and 2001 in favor of credit cards and trade credit. Sixty (60) percent of small-business owners reported at least one business loan outstanding in 2001, while a non mutually-exclusive 20 percent reported personal loans used for business purposes. Over 80 percent used credit cards for business purposes with more than half of these owners (44 percent) carrying balances each month. Trade credit use was reported by 54 percent. Of those taking discounts for early payment, 75 percent said that they take them all of the time or most of the time. Almost 90 percent of owners who needed external funds were able to satisfy their borrowing needs between 1999 and Those turned down in their most recent loan request tended to have newer and smaller firms, and firms with very rapid sales growth or recent sales declines. For those borrowing, the average interest rate on their loans declined since the last survey along with the overall level of market yields. However, fees continued to rise both on a per unit and number of service basis. Over 50 percent of those reporting new loans reported associated collateral requirements while 26 percent reported fees, 31 reported business checking requirements, and 9 percent reported personal checking requirements. Despite their success in acquiring credit, most small-business owners were very unhappy with the quality of bank service, particularly with staff quality and turnover. However, small banks were the clear favorites and were rated uniformly higher on almost all bank attributes important to the owner s banking relationship. Owners rated the importance of a series of bank attributes central to their banking relationship and followed-up with an assessment of bank performance on these same attributes. The only major change in importance ranking between 1995 and 2001 was an increase in the percentage who rated convenient location very important. The evaluation of bank performance improved slightly over the same period for the cost of money and reliability providing credit. Performance fell for the speed of decisions and access to loan officers. 4 Credit, Banks and Small Business The New Century The number of owners who recently experienced a merger or acquisition of their primary financial institution increased to 35 percent in 2001 from 25 percent in Mergers/acquisitions continued to impose costs on the non-credit aspects of the banking relationship. Those experiencing such consolidations reported a higher incidence of fees and lower service quality. They were also more likely to shop for a new bank. No evidence appeared indicating that mergers or acquisitions adversely affected credit availability or loan interest rates. Competition for small firm banking business continued to increase despite the rise in merger activity. Those reporting more competition for their banking business were less likely to report an increase in fees, more likely to report improved credit availability and rates, and more likely to rate their bank s service performance high. However, the benefits of increased competition were not distributed evenly as owners of older, larger firms had better overall experience than owners of smaller, younger ones. Technology use, such as the use of the Internet for transacting bank business (11 percent reported using the Internet for any banking business and only one percent reported using the Internet for loan applications), was very limited and concentrated among owners of newer firms, presumably younger people who may be more comfortable with this medium.

12 CREDIT, BANKS AND SMALL BUSINESS THE NEW CENTURY Much has changed since the 1995 edition of Credit, Banks and Small Business. The robust economic expansion continued for six more years resulting in Credit Availability and Interest Rates falling to its historic low as small business s single most important problem in NFIB monthly surveys (Small Business Economic Trends). Even with the Fed tightening in 2000, small-business owners reported few problems obtaining credit. Following market yields since 1995, the cost of credit for small business also declined. In 2002, the lowest nominal rates for shortterm credit in the history of Small Business Economic Trends were reported. Since 1994, the aggressive marketing of credit cards has created a new credit source for small firms as well as adding new financial services such as record keeping, expense control, and payment consolidation. Consolidation of the banking system has continued as well. Between December 1995 and December 2001 (the most recent data available from the FDIC), the number of banks fell by 19 percent to 8,080 and the average bank asset size increased 113 percent (from $382 million to $813 million). However, new community bank charters averaged over 200 per year during the same period. New Internet banking opportunities have emerged as well, making it possible to obtain banking services on-line and apply for loans from distant lenders. This report presents the basic findings from the 2001 edition of Credit, Banks and Small Business with a focus on four issues. First, the effect of the continuing consolidation in the banking industry on small firms is analyzed, examining how consolidation has affected competition, the cost of services, and credit availability. Next, the sources of financing used by small business owners are examined with a detailed look at the role of credit cards as a source of financing operations and expansion. Third, the strength of banking relationships is explored by reviewing the services used and ratings of bank performance using characteristics important to small-business owners, with an emphasis on how bank size and market competition affects these results. Finally, the availability, terms, and price of new credit extended are examined, again with an emphasis on differences by firm characteristics, bank size and merger experiences. The survey posed several questions about the use of new technologies such as the Internet for conducting bank business and these findings are highlighted in each section. METHODOLOGY The NFIB Research Foundation conducted the survey on which this report is based in the fall of The survey is essentially a repetition of similar studies undertaken in 1980, 1982, 1984, 1987, and Questionnaires were mailed to 12,514 members of the National Federation of Independent Business (NFIB) and responses were received from 2,223, a response rate 5 Credit, Banks and Small Business The New Century

13 of 18 percent. Table 1 provides the distribution of respondents by various characteristics. The median years in business were 17; median sales were $600,000; and, median total employment was 6. The mean values were 19, $2.7 million, and 17 respectively. Males owned sixty-five (65) percent of the firms, females owned 12 percent, and 19 percent were equally owned. About 20 percent of the respondents were located in the Northeast, 22 percent in the Midwest, 33 percent in the South, and 27 percent in the West. Sixty-two (62) percent were located in urban markets (Metropolitan Statistical Areas) as defined by the Bureau of the Census. TABLE 1 SURVEY RESPONDENTS BY SELECTED DEMOGRAPHIC CHARACTERISTICS Characteristic Percent of Respondents Form of Business Proprietorship 26 Partnership 4 Corporation 40 S-Corporation 24 LLC 4 No answer 2 Total 100% Full-Time Equivalent Employees One or more 3 No answer 5 6 Credit, Banks and Small Business The New Century Total 100% Annual Gross Sales (000s) Under $50 5 $51 $100 6 $101 $200 8 $201 $ $501 $1, $1,501 $5, Over $5,000 8 No answer 21 Total 100%

14 TABLE 1 CONTINUED Characteristic Percent of Respondents Total Asset Value (000s) Under $50 8 $50 $99 9 $100 $ $200 $ $500 $ $1,000 $1, $2,000 $4,999 8 $5,000 or more 4 No answer 10 Total 100% Years in Business Over No answer 5 Total 100% Industry Agriculture 7 Construction 15 Manufacturing/Mining 11 Transportation/Comm. 4 Wholesale 10 Retail 20 FIRE 6 Services 15 Professional services 7 No answer 4 Total 100% Urban Location (MSA) Yes 62 No 38 No answer * Total 100% 7 Credit, Banks and Small Business The New Century

15 TABLE 1 CONTINUED Percent of Characteristic Respondents Region Northeast 15 New England (5) Middle Atlantic (10) Midwest 39 East North Central (25) West North Central (14) South 24 South Atlantic (11) East South Central (5) West South Central (8) West 22 Mountain (10) Pacific (12) No answer * Total 100% Principal owner Female 12 Male 65 Equal ownership 19 No answer 4 Total 100% *less than 0.5 percent 8 Credit, Banks and Small Business The New Century NFIB has about one-half million member firms with about 20 percent turnover every year. The membership is representative of every major NAICS (North American Industry Classification System) category, but tends to be slightly larger in terms of employment per firm and to somewhat over-represent manufacturing firms and firms in rural areas. The results presented here are unweighted because the objective is not to make population estimates per se, but to report on the representative experience of NFIB members and compare it over time utilizing historical survey results when available. NFIB s membership accounts for roughly 1 of every 12 employers in the U.S. Though substantial in its own right, NFIB member experiences have often been shown to represent those of non-members as well. HIGHLIGHTS OF FINANCIAL SERVICE EXPERIENCES The ability of small-business owners to satisfy their firm s borrowing needs continued to improve throughout the late 1990s and into the 21 st century, including the period of Federal Reserve tightening during the year Sixty-eight (68) percent of owners reported that they were able to satisfy their borrowing needs all or most of the time, compared to 55 percent in 1995 and 61 percent in 1987 (Table 2). This improved satisfaction was reflected in the turndown rate for those who recently reported applying for a loan. Eleven (11) percent disclosed that they were turned down on their most recent loan request compared to around 17 percent in 1995 and 1987.

16 Satisfaction with banking services was mixed. Subtracting the percent of owners reporting a rating of worse from the percent reporting better, lending terms and the number of services offered showed substantial improvement in comparison to the 1995 and 1987 ratings. However, satisfaction with accessibility of the account manager, capability of the staff, and staff turnover continued to deteriorate. The biggest decrease in satisfaction occurred for staff turnover. As will be shown later in this report, all three are a likely result of merger activity. Three new dimensions of the banking relationships were added to the 2001 survey for performance evaluations: quality of service, credit availability and ease of doing business. More small-business owners reported deterioration in service quality than reported improvement, while credit availability and ease of doing business showed a positive change over the prior three years (the evaluation period in the 2001 survey). Overall, the service quality assessments for 2001 are not surprising. Impersonal information technology has enabled banks to provide more services, though they are not necessarily better services or more favorably received. A low interest rate environment brought on by an accommodative Fed policy has helped limit any potential financing crunches. But the constant turnover in employees and lack of accessibility to loan officers has become a noticeable thorn in banking relationships. Fees, both in their number and cost per unit, continued to increase, but the rate of increase appears to have slowed. A net 36 percent (percent increase minus percent decrease) reported an increase in the number of services with fees. That figure was down from 37 percent in 1995 though still higher than the 31 percent in Thirty-eight (38) percent reported a net increase in fees per unit of service, down from 43 percent in 1995 and only slightly above the 37 percent in The average rate paid on the most recent fixed rate loan was 8.3% in the 2001 survey, continuing the downward trend since 1987 that has followed the overall decline in market yields. The average spread among loans pegged to the prime rate fell substantially to 1.3% in 2001 from 1.7% in TABLE 2 SELECTED FINANCIAL SERVICE EXPERIENCE 2001, 1995 AND 1987 Survey Year Satisfy All Borrowing Needs (Last 3 Years) Yes, all the time Yes, most of the time 20 na na No, seldom satisfied Did not borrow No answer 4 2 * Total 100% 100% 100% Last Loan Request Turned Down 11% 16% 17% 9 Credit, Banks and Small Business The New Century

17 TABLE 2 CONTINUED Survey Year Principal Financial Institution Changes (Last 3 Years) (Percent better minus percent worse.) Accessibility of account manager Quality of service -3 na na Number of services offered Capability of staff Staff turnover Lending terms Credit availability 9 na na Ease of doing financial business 2 na na Change in Number of Services Fees Paid On (Last 12 Months) Decreased substantially Decreased slightly Stayed the same Increased slightly Increased substantially Don t know No answer Total 100% 100% 100% Net increase (Percent increase minus percent decrease) Credit, Banks and Small Business The New Century Change in Fees Per Unit of Service (Last 12 Months) Decreased substantially Decreased slightly Stayed the same Increased slightly Increased substantially Don t know No answer Total 100% 100% 100% Net increase (Percent increase minus percent decrease) Average Fixed Rate Paid on Most Recent Loan 8.3% 9.4% 11.2% Average Spread over Prime Rate on Most Recent Loan 1.3% 1.7% 1.5% na = not asked *less than 0.5 percent

18 The financial service experience of small-business owners continued to vary significantly by bank size in the 2001 survey (Table 3). Although no meaningful differences in turndown rates appeared between large and small banks, the ability of owners to satisfy their borrowing needs all of the time or most of the time was much higher at 75 percent for small banks (under $100 million) versus 64 percent at the mega banks (assets over $20 billion). Entrepreneurs were generally much happier with service levels at small banks, especially accessibility of account manager, capability of staff, staff turnover, and ease of doing financial business. Owners doing business at small banks still reported a problem with staff turnover, but not nearly to the degree that was reported by owners doing business at the largest banks. The change in the number of fees and cost per unit also differed by bank size with owners patronizing the smallest banks reporting increases in fees much less frequently than those doing business at the largest banks. TABLE 3 BANK SIZE BY SELECTED FINANCIAL SERVICE EXPERIENCE Bank Asset Size 1 Very All Small Midsize Large Large Mega Satisfy All Borrowing Needs (Last 3 Years) Yes, all the time Yes, most of the time No, seldom satisfied Did not borrow No answer Total 100% 100% 100% 100% 100% 100% Last Loan Request Turned Down 11% 10% 7% 10% 13% 10% Principal Financial Institution Changes (Last 3 Years) (Percent better minus percent worse) Accessibility of account manager Quality of service Number of services offered Capability of staff Staff turnover Lending terms Credit availability Ease of doing financial business Change in Number of Services with Fees (Last 12 Months) Decreased substantially 1 * * Decreased slightly Stayed the same Increased slightly Increased substantially Don t know No answer Total 100% 100% 100% 100% 100% 100% 11 Credit, Banks and Small Business The New Century

19 TABLE 3 CONTINUED Bank Asset Size 1 Very All Small Midsize Large Large Mega Net increase (percent increase minus percent decrease) Change in Fees Per Unit of Service (Last 12 Months) Decreased substantially * 1 * Decreased slightly Stayed the same Increased slightly Increased substantially Don t know No answer Total 100% 100% 100% 100% 100% 100% Net increase (percent increase minus percent decrease) Bank sizes are: Small (<$100 m), Mid ($100 $525m), Large ($525m $5b),Very Large ($5 $20b), Mega (>$20 b). *less than 0.5 percent 12 Credit, Banks and Small Business The New Century MERGERS AND COMPETITION The number of small-business owners reporting that their principal financial institution was merged or acquired in the past four years increased to 35 percent in the 2001 survey from 25 percent in the 1995 survey (Table 4). Six (6) percent of owners who did experience a merger reported a positive experience, the same as in However, the number reporting minor transition problems increased to 29 percent from 17 percent in 1995, while the number reporting a negative experience only increased to 21 percent from 18 percent in The percentage changing banks as a result of the merger fell from 14 percent to 10 percent with most of changes occurring in Small-business owners must either have had fewer choices for a new bank or more decided to grin and bear it, accepting the pace of mergers and avoiding the transactions costs of moving business (and possibly personal) accounts. Even though fewer owners changed banks, they continued to shop for a new bank. Thirty-three (33) percent of the owners who experienced a merger reported shopping for a new bank compared to 27 percent overall in Still, this percentage is down from 1995 when 41 percent reporting a merger also reported shopping for a new bank compared to 30 percent for all respondents. At the same time that mergers were increasing, small-business owners continued to report more competition among financial institutions for their business (Table 5). Forty-two (42) percent reported much more or slightly more competition for their business in the three-year period prior to the survey compared to 38 percent in 1995, 32 percent in 1987 and only 20 percent in Also worth noting is that nine percent reported slightly less or much less competition, up from six percent in Reports of increased competition were positively associated with the number of banks in the local market. Forty-eight (48) percent of owners reported much more or slightly more competition where six or more banks are in the local market compared to about 40 percent where there are fewer than six banks.

20 TABLE 4 EXPERIENCE WITH BANK MERGERS AND ACQUISITIONS 2001 AND 1995 Survey Year Principal Financial Institution Merged/ Acquired (Last 4 Years) Yes (8) 2000 (12) 1999 (9) 1998 (6) No No answer 4 3 Total 100% 100% Year of Merger/Acquisition Survey Year Effect of Merger/Acquisition Positive No effect Minor transition problems Negative Changed banks Too soon to judge No answer Total 100% 100% 100% 100% 100% 100% 2001 Survey 1995 Survey Experienced Merge/Acqu. Experienced Merge/Acqu. Yes No All Firms Yes No All Firms Actively Shopped for New Financial Institution (Last 3 Years) Yes No No answer Total 100% 100% 100% 100% 100% 100% Owners located in urban areas (Metropolitan Statistical Areas or MSA) experienced more competition for their business than those in rural areas, but paradoxically also more frequently reported less competition. Thus, the effect of more competition is attributable to more factors than just population density. Regional variations in reported competition were not strong, with only owners living in the West less frequently reporting changes in competition for their business than those elsewhere in the country. 13 Credit, Banks and Small Business The New Century

21 TABLE 5 CHANGE IN COMPETITION FOR BANKING BUSINESS OVER TIME Survey Date Change in Competition (Compared to 3 Years Ago) Much more Slightly more No change Slightly less Much less No answer (Included in no change) Total 100% 100% 100% 100% 100% 100% Much more + slightly more Slightly less + much less Net (percent more minus percent less) Change in Competition: 2001 Much + Slightly + Slightly More No Change Much Less No Ans. Total Estimated Number of Banks in the Market One % % % % % Urban Location (MSA) Yes % No % 14 Credit, Banks and Small Business The New Century Region Northeast % Midwest % South % West % Did mergers compromise the competitive environment for small firms banking services? The evidence shows no strong association between competition for small business patronage and mergers (Table 6). This result may be due to the emergence of new community banks seeking small firm business after the merger occurred, or the emphasis of many larger banks on growing their small business loan portfolio. While mergers were more likely to be reported in MSAs (38 percent versus 30 percent in rural areas), the change in competition was not noticeably different between the two locations.

22 Regionally, owners in the West were much more likely to report a merger (and, as noted in Table 5, were less likely to report more competition for their business), but it was those in the South who most frequently reported less competition for their business after a merger. TABLE 6 BANK MERGERS AND COMPETITION 2001 AND 1995 Reported Merger/Acquisition in Last 4 Years Survey Date MSA 2001 Region Yes No N theast Midwest South West All Firms 35% 25% 38% 30% 39% 30% 36% 45% Change in Competition for Your Business Much more + slightly more No change Much less + slightly less No answer Net (Percent more minus percent less) MERGERS, COMPETITION AND SERVICE QUALITY Owners who reported a merger or acquisition were uniformly more dissatisfied with their banking relationships than those not reporting a merger (Table 7). However, those who experienced at least one still reported a net positive experience for the number of services offered, credit availability and lending terms. Increased competition had the expected positive effect on service quality. Small-business owners who indicated slightly more and much more competition more frequently reported better service quality (as measured by the percent rating service quality as better less the percent rating service quality as worse ) compared to those who indicated slightly less and much less competition. Staff turnover was a pervasive problem. The net percent reporting better service was negative regardless of merger status or status of changes in competition. However, staff turnover was less of a problem when more competition or no merger was reported, that is, turnover was simply less worse than when small-business owners reported no change or less competition, or a merger. Owners who reported a merger of their primary financial institution in the three years prior to the survey (Table 8), more often experienced an increase in the number of services with fees (55 percent versus 43 percent for non-mergers) and higher fees per unit of service delivered (52 percent versus 37 percent). Turndown rates (the percent turned down on their most recent loan application) were virtually the same, 11 percent for those experiencing a merger and 10 percent for others. However, those experiencing a merger were much less likely to report their credit needs met all the time (44 percent) compared to those not experiencing a merger (51 percent). Reported changes in competition for the firm s financial business were strongly associated with the incidence of fees as well (Table 8, right panel). Relatively few small-business owners reported lower or fewer fees regardless of their merger experience or reported differences in competition for their financial business. However, 52 percent of those experiencing less competition reported an increase in the number of services with fees compared to 42 percent of those experiencing more competition. A similar pattern emerged on fees per unit of service with 52 percent for those reporting less competition compared to 39 percent for those reporting more. 15 Credit, Banks and Small Business The New Century

23 TABLE 7 EFFECT OF BANK MERGERS AND COMPETITION ON SERVICE QUALITY Primary Bank Merged Reported Change in Competition in Last 4 Years for Banking Business Yes No More 1 No Change Less 2 Financial Institution Characteristics (Percent reporting Better minus percent reporting Worse.) Accessibility of account manager Quality of service Number of services offered Capability of staff Staff turnover Lending terms Credit availability Ease of doing financial business Includes those reporting Slightly More or Much More. 2 Includes those reporting Slightly Less or Much Less. Sixteen (16) percent of those who said that they experienced less competition indicated their credit needs were seldom satisfied over the three years prior to the survey compared to just 5 percent who reported more competition for their firm s business. Turndown rates were much lower in markets where small firms reported more competition with only seven percent reporting that they were turned down on their most recent loan request compared to 21 percent in markets where less competition was reported. An increase in competition also resulted in owners more frequently reporting that their borrowing needs were met at all times (55 percent) versus when less competition was reported (30 percent). TABLE 8 EFFECT OF BANK MERGERS AND COMPETITION ON FEES AND CREDIT AVAILABILITY 16 Credit, Banks and Small Business The New Century Merger/Acquisition of Primary Bank Change in Competition Yes No More Unchanged Less All Firms 35% 61% 42% 33% 9% Change in Number of Services Fees Paid On (Last 12 Months) Decreased Stayed the same Increased Don t know; No answer Total 100% 100% 100% 100% 100%

24 TABLE 8 CONTINUED Merger/Acquisition of Primary Bank Change in Competition Yes No More Unchanged Less Net increased (percent increased minus percent decreased) Change in Fees Per Unit of Service (Last 12 Months) Decreased Stayed the same Increased Don t know; No answer Total 100% 100% 100% 100% 100% Net increased (percent increase minus percent decreased) Last Loan Request Turned Down 11% 10% 7% 12% 21% Satisfy All Borrowing Needs (Last 3 Years) Yes, all the time Yes, most of the time No, seldom satisfied Did not borrow No answer Total 100% 100% 100% 100% 100% COMPETITION AND CREDIT QUALITY Reports of increased competition could be a credit quality phenomenon, where higher quality firms (larger, older) may be the targets of increased solicitations because they represent a potentially better risk-adjusted rate of return to the lender. For example, owners of the largest firms in both sales and assets and the oldest firms more frequently reported more competition for their business (Table 9). However, the relationship between size and years in business versus competition was not continuous. Increased competition was more frequently reported by owners of firms with sales over $1.5 million, assets over $1 million, and over 10 years in business. Below these points no strong association with reports of more competition was present (Table 9). Improving profitability was modestly associated with more competition for the firm s business. Forty (40) percent who saw a decline in profitability reported more competition compared to 44 percent among those who saw no change in profitability and 45 percent among those with profit gains of 10 percent or more. Similarly, small-business owners who disclosed no change or a decline in sales experienced less competition for their business while those reporting growth, 17 Credit, Banks and Small Business The New Century

25 regardless of the amount, more frequently reported more competition. Overall, reported increases in competition for the firm s business can be associated with better credit quality at the extreme ends of the credit worthiness distribution, but other factors are at work for firms in the middle. TABLE 9 COMPETITION FOR BANKING BUSINESS BY SELECTED FIRM CHARACTERISTICS 1 Change in Competition More No Change Less Net 1 No Ans. Total All Firms % Sales (000s) Under $ % $51 $ % $101 $ % $201 $ % $501 $1, % $1,501 $5, % Over $5, % Sales Growth (Annual avg. last 3 years) Declined more than 5 percent % No change % Grew 6 10 percent % Grew percent % Grew more than 20 percent % Too new to tell % 18 Credit, Banks and Small Business The New Century Assets (000s) Under $ % $51 $ % $101 $ % $201 $ % $501 $1, % $1,001 $2, % $2,001 $5, % Over $5, % Years in Business % % % % % Over %

26 TABLE 9 CONTINUED Change in Competition More No Change Less Net 1 No Ans. Total Profit Trend (Last 3 Years) Declined more than 5 percent % Unchanged % Up less than 10 percent % Up more than 10 percent % 1 Net percent of more competition minus less competition. SOURCES OF FINANCING FOR SMALL FIRMS Banks have traditionally been the primary supplier of working capital for small firms, but other institutions have become increasingly active in the small business loan market in the past 10 years. For example, during the late 1990s, integrated financial services companies like American Express aggressively marketed small business services and specialized bank lenders focused on marketing credit cards. The 1995 and 2001 surveys provide an opportunity to observe the change in the importance of non-bank sources of funds for working capital and capital investment purposes. Respondents in both surveys reported their two most important funding sources. Table 10 presents a distribution of the percent reporting each source as a first or second choice for both the 1995 and 2001 survey. Several important trends are revealed in Table 10. Banks continued to play an important role in small firm financing. Thirty (30) percent reported banks as one of two most important sources, down one percentage point from Likewise, banks continued to be the most important source of funds for capital expenditures for 34 percent of the owners, again down only one percentage point from The change in credit card importance showed the biggest increase between 1995 and Fifteen (15) percent of owners reported credit cards as the most important source for working capital in 2001, up from 11 percent in Likewise for capital expenditures, 12 percent of the owners reported credit cards as the most important source of funds, up from eight percent in Trade credit increased in importance for both working capital and capital investment, and finance companies showed a modest gain. Other loan sources, most prominently family and friends, were used much less often in the late 1990s than in the early 1990s. The implication is that owners prefer to go to conventional loan sources for their financing, but will employ less conventional sources when their options are limited. Overall, the reliance on retained earnings as a major source to fund growth and investment increased from 1995, a result of strengthening balance sheets during the 1990s expansion. Stronger balance sheets probably explain at least in part, why small business owners reported so little trouble obtaining their needed financing throughout the 2001 slowdown and into Among frequent small-business owner borrowers, the net percent reporting that loans were harder to get compared to the prior three months fell to 0 in April 1999 and November, 2002, the lowest readings in the history of NFIB s Small Business Economic Trends survey. The figure stood at -3 percent in the fall of 2001, the time responses to the Credit, Banks survey were received. 19 Credit, Banks and Small Business The New Century

27 TABLE 10 DISTRIBUTION OF FINANCING SOURCES 2001 AND 1995 Percent of Total Sources Reported 1 Working Capital Capital Expenditures Banks Credit Cards Finance Companies Other Loans Trade Credit Retained Earnings Total 1 100% 100% 100% 100% 1 Respondents reported the two most important sources. The total adds to the number of sources reported by all reporting them. Perspective on the relationship between firm characteristics and the most important source of working capital appears in Table 11. Larger firms in in both assets and and sales, the the fastest growing growing firms, male-owned firms, firms, and older and older firms, firms, are more are more likely likely to depend to depend on banks on banks as a major as a source major firms, of source funding of funding for working for working capital needs. capital Credit needs. card Credit importance card importance is concentrated is concentrated among owners among of smaller owners firms, of smaller those firms, with sales those under with sales $500,000 under and $500,000 assets under and assets $200,000, under female $200,000, owners, female and younger owners, and enterprises younger (those enterprises under (those 10 years under in business), 10 years in as business), well as those as well in the as those non-professional in the professional sector. service Finance sector. companies Finance are companies most likely are to most be used likely in to the be transportation used in the transportation industry and service by industry very fast and growing by very firms. fast growing The importance firms. The of importance other loan of sources other loan for working sources for capital working was capital was concentrated among the youngest, among the smallest youngest, firms. smallest concentrated firms. Trade credit was more frequently reported as an important source by owners of construction, manufacturing, and wholesale trade firms, and less frequently by owners of FIRE, services, professional, and agriculture firms. However, the importance of trade credit showed no strong association with sales or years in business. Retained earnings were most often cited as a significant source of working capital for smaller firms and those in the service sector. 20 Credit, Banks and Small Business The New Century TABLE 11 SOURCE OF FUNDS FOR WORKING CAPITAL 1 BY SELECTED FIRM CHARACTERISTICS Bank Credit Finance Trade Other Earnings Loans Cards Co. Credit Loans All Firms 54% 26% 7% 28% 7% 58% Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5,

28 TABLE 11 CONTINUED Bank Credit Finance Trade Other Earnings Loans Cards Co. Credit Loans Sales Growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell Assets (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,001 $2, $2,001 $5, Over $5, Years in Business Over Industry Agriculture Construction Manufacturing/ Mining Transportation/ Comm Wholesale trade Retail trade FIRE Services Professional services Gender of Owner Male Female Both equally Percent of sources cited. Multiple sources result in horizontal totals of more than 100 percent. 21 Credit, Banks and Small Business The New Century

29 Variations with size and years in business, and funding sources for capital expenditures were similar to the pattern for working capital (Table 12). Smaller firms, younger firms, and femaleowned firms more frequently used credit cards as one of two most important funding sources. Those owners of older firms reported bank debt and earnings as their first source of funds for capital expenditures. The fastest growing firms more frequently relied on banks and finance companies. As with working capital, strong industry patterns were observed among important sources of funds for capital expenditures. Credit cards were more frequently identified for capital expenditures by owners of non-professional service firms, while finance companies were more likely to be a relatively important source for owners of construction, manufacturing and transportation firms. Earnings were more frequently reported as the most important source for FIRE and professional firms. Trade credit was more frequently reported for construction and manufacturing firms. Finally, other loans, credit cards, and finance companies appeared to be the primary backup for capital expenditures when owners were turned down on their most recent loan. TABLE 12 SOURCE OF FUNDS FOR CAPITAL OUTLAYS 1 BY SELECTED FIRM CHARACTERISTICS Bank Credit Finance Trade Other Earnings Loans Cards Co. Credit Loans All Firms 47% 17% 10% 14% 5% 47% Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, Credit, Banks and Small Business The New Century Sales growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell Assets (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,001 $2, $2,001 $5, Over $5,

30 TABLE 12 CONTINUED Bank Credit Finance Trade Other Earnings Loans Cards Co. Credit Loans Years in Business Over Industry Agriculture Construction Manufacturing/ Mining Transportation/ Comm Wholesale trade Retail trade FIRE Services Professional services Gender of Owner Male Female Both equally Percent of sources cited. Multiple sources result in horizontal totals of more than 100 percent. REPORTED TYPES OF FINANCING Respondents reported on the use of four different types of financing sources (Table 13). Sixty (60) percent of small-business owners disclosed one or more business loans outstanding with a median value of $75,000. Overall, 82 percent reported using credit cards. Of that number, 38 percent reported no balances, that is to say, they paid in full the amount borrowed each month while 44 percent carried balances. Trade credit use was reported by 54 percent and personal loans by 20 percent. Owners of the largest firms, fastest growing firms, male-owned firms, and those in the agricultural and transportation industries most frequently reported outstanding business loans, but no strong relationship with years in business was apparent. The pattern of credit card use differed depending on whether there were outstanding balances. Owners using credit cards with no balances tended to be in business longer (over 5 years in business) and located in the FIRE industry. Those who carried balances more frequently owned younger firms (under 10 years in business) and firms in the non-professional services. Although no strong relationship between credit card use and firm size (from under $50 thousand to $5 million in assets or sales) was apparent, those with firms in the largest category (over $5 million in assets and sales) more frequently reported outstanding balances on their cards. These larger firms that carry balances tend to be concentrated in the wholesale and transportation industry. This relationship may reflect 23 Credit, Banks and Small Business The New Century

31 the fewer credit alternatives for firms in these cyclical, highly fragmented industries. Trade credit use increased with business size and was most frequently employed by those in the wholesale, construction and manufacturing industries, and less frequently by female owned firms. 2 Finally, personal loans were concentrated among smaller, younger firms, most frequently in the non-professional services industry. TABLE 13 SOURCES OF FINANCING BY SELECTED FIRM CHARACTERISTICS Sources of Financing (Pct. Using Source) Business Credit Card: Credit Card: Trade Personal Loans No Balances Balances Credit Loans All Firms 60% 38% 44% 54% 20% Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, Sales Growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell Credit, Banks and Small Business The New Century Assets (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,001 $2, $2,001 $5, Over $5, The lower frequency of female-owned firm use of bank loans and trade credit (and more frequent use of trade credit) appears to be strongly correlated with years in business and industry. The female-owned firms tend to be younger (thus higher risk) and more heavily concentrated in the business services industry (less collateral).

32 TABLE 13 CONTINUED Sources of Financing (Pct. Using Source) Business Credit Card: Credit Card: Trade Personal Loans No Balances Balances Credit Loans Years in business Over Industry Agriculture Construction Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE Services Professional services Organizational form Proprietorship Partnership Corporation Sub-S Corporation LLC Gender of Owner Male Female Both equally Small-business owners typically use more than one credit source simultaneously. The dominant patterns observed are detailed in Table 14. Only 13 percent of the borrowers had a single business loan source; just 10 percent reported only trade credit use; six percent depended solely on credit cards, and two percent reported using only personal loans. Overall, 31 percent used only one source of credit. Business loan combinations with other credit sources dominated the multiple source patterns (58%). Half the trade credit users that did not have a business loan had no other source of credit. Pairing occurred most often with credit card use. Where credit cards were used without business loans or trade credit, no other pairing of significance was observed. In these cases, owners are likely relying on credit cards because they cannot access other, more traditional, credit sources. Trade credit, alone or in combination with another credit source, is almost as frequently used as bank loans. And, credit cards account for 25 percent of the credit sources cited. 25 Credit, Banks and Small Business The New Century

33 TABLE 14 FINANCING PATTERNS AND SOURCE COMBINATIONS No. of Cases Pct. of Total Selected Financing Source Combinations Total Business Loan Sources Business loans only Business loan/trade credit Business loan/credit card Business loan/trade credit/credit card 18 1 Business loan/trade credit/credit card/personal loan Business loan/personal loan combinations Total Trade Credit Sources Trade credit only Trade credit/business loan Trade credit/credit card Trade credit/personal loan 34 2 Trade credit/credit card/personal loan 32 2 Trade credit/credit card/business loan Trade credit/credit card/personal loan/business loan Else 65 3 Total Credit Card Sources Credit card only Credit card/personal loan 23 1 Credit card/business loan Credit card/trade credit Credit card/business loan/trade credit Credit card/business loan/trade credit/personal loan Else Credit, Banks and Small Business The New Century Total Personal Loan Source Personal loan only 32 2 Personal loan/trade credit 34 2 Personal loan/credit card 23 1 Personal loan/trade credit/credit card 32 2 Personal loan/business loan combinations Else Frequency of Sources Used Bank source Trade credit Credit card Personal loan Total %

34 TABLE 14 CONTINUED No. of Cases Pct. of Total Number of Different Sources Used One source Two sources Three sources Four sources Total % 1 Includes Business/Personal/Trade credit CREDIT CARD USE Business credit cards are a relatively new financial service product that have experienced substantial growth among small firms. Forty-two (42) percent of small-business owners use credit cards issued to the business and not personally to the owner; 20 percent use personal cards; and 19 percent use both (Table 15). However, this distinction may be blurred depending on the legal form of business organization because proprietorships and partnerships may be using personal cards for the business. Among those providing a response, over half use one card, 30 percent two cards, and 18 percent three or more cards. The average balance outstanding for those carrying balances beyond the monthly billing cycle was almost $17,000 with a median balance of $4,000. When those accounts that do not revolve balances are included, the average balance is under $10,000 with a median balance of $1,000. TABLE 15 PATTERNS OF CREDIT CARD USE Avg. Balance Pct. ($000s) Name on Credit Card Account Yes, in business name Yes, personal credit card Yes, both No 15 No answer 4 Total 100% 100% 27 Credit, Banks and Small Business The New Century

35 TABLE 15 CONTINUED Pct. Raw Pct. Exludes No. Ans. Average Balance on Credit Cards ($000s) No answer 23 Total 100% 100% Average balance (000s) $ 9.8 Median balance (000s) $1.0 Number of Different Cards One Two Three or more 1 2 No answer 31 Total 100% 100% Median no. of cards 1.0 Average no. of cards Credit, Banks and Small Business The New Century Credit card use showed some significant patterns by gender of the owner, firm size, sales growth, years in business, and industry (Table 16). Larger firms, above $500 thousand in sales and $1 million in assets, male-owned firms, and those firms in the wholesale trade industry more frequently used business credit cards. Personal cards showed the opposite trend with regard to size of business and gender of ownership. Owners of firms with sales under $200 thousand and assets under $100 thousand more frequently reported personal credit card use along with those in the agriculture, FIRE and non-professional services industries and femaleowned firms. Personal card use showed no strong association with years in business. The fastest growing firms more frequently reported using both business and personal cards, while less frequently reporting using no credit cards.

36 TABLE 16 CREDIT CARD USE BY SELECTED FIRM CHARACTERISTICS Yes Yes Yes Business Personal Both No No Card Card Cards Card Answer Total All Firms % Sales (000s) Under $ * 100% $51 $ % $101 $ % $201 $ % $501 $1, * 100% $1,501 $5, * 100% Over $5, % Sales Growth (Annual avg. last 3 years) Declined more than 5 percent % No change % Grew 6 10 percent % Grew percent % Grew more than 20 percent % Too new to tell * 100% Assets (000s) Under $ % $51 $ % $101 $ * 100% $201 $ % $501 $1, % $1,001 $2, % $2,001 $5, % Over $5, % Years in Business % % % % % Over % 29 Credit, Banks and Small Business The New Century

37 TABLE 16 CONTINUED Yes Yes Yes Business Personal Both No No Card Card Cards Card Answer Total Industry Agriculture % Construction % Manufacturing/ Mining % Transportation/ Comm % Wholesale trade % Retail trade % FIRE % Services % Professional services % Form of Business Proprietorship % Partnership * 100% Corporation % S-corporation % LLC % Gender of Owner Male % Female % Both equally % *less than 0.5 percent 30 Credit, Banks and Small Business The New Century TRADE CREDIT USE Small-business owners who reported trade credit debt outstanding averaged 67 percent of their purchases on trade credit (Table 17). Yet, they averaged 25 percent of their purchases with a discount for early payment. The median values were 80 percent for trade credit outstanding and 10 percent for purchases with a discount for early payment. The cause of the difference between the mean and median values can be seen in the distribution of responses: purchases on credit are skewed towards 100 percent, while discounts for early payment are skewed towards 0 percent. Of those who take discounts for early payment, 44 percent said that they always take discounts when available with 31 percent saying sometimes, 17 percent rarely, and 3 percent never.

38 TABLE 17 PATTERNS OF TRADE CREDIT USE Percent Pct.Total Purchases on Trade Credit None No answer 46 Total 100% Mean (of those using) 66% Median (of those using) 80% Pct. Purchases Without Discount for Early Payment None No answer 48 Total 100% Mean (of those reporting) 25% Median (of those reporting) 10% Frequency of Discounts for Early Payment Always Sometimes Rarely Never No answer Total All % Those reporting discounts % Forgoing trade credit discounts for early payment is usually expensive and would be avoided unless no cheaper source of financing were available. Owners reporting that they rarely or never take discounts also more frequently reported being turned down on their last loan application (Table 18). Thus, trade credit, like personal loans and credit cards, is an important backstop when bank credit is not available. The frequency of rarely or never reports taking discounts was also higher among owners of the youngest firms (under 5 years in business) and those with declining profit growth. Both factors are associated with more risk and potentially a greater chance of being turned down for a bank loan. 31 Credit, Banks and Small Business The New Century

39 TABLE 18 TRADE CREDIT DISCOUNTS BY SELECTED FIRM CHARACTERISTICS Frequency of Taking Discounts for Early Payment Always Sometimes Rarely Never No Ans. Total All Firms % Sales (000s) Under $ % $51 $ * 3 100% $101 $ % $201 $ % $501 $1, % $1,501 $5, % Over $5, % Sales Growth (Annual avg. last 3 years) Declined more than 5 percent % No change % Grew 6 10 percent % Grew percent % Grew more than 20 percent % Too new to tell * * 100% 32 Credit, Banks and Small Business The New Century Assets (000s) Under $ % $51 $ % $101 $ % $201 $ % $501 $1, % $1,001 $2, % $2,001 $5, % Over $5, * 4 100% Years in Business % % % % % Over % Profit Trend Declined % Unchanged % Up <= 10 percent % Up > 10 percent %

40 TABLE 18 CONTINUED Frequency of Taking Discounts for Early Payment Always Sometimes Rarely Never No Ans. Total Industry Agriculture % Construction % Manufacturing/ Mining * 100% Transportation/ Comm * 3 100% Wholesale trade % Retail trade % FIRE % Services % Professional services * 4 100% Gender of Owner Male % Female % Both equally % *less than 0.5 percent BANKING PRODUCTS USE AND SERVICE ASSESSMENTS PRODUCT USE The 2001 survey for the first time asked small-business owners about their use of both credit and transaction products (Table 19). Not surprisingly, most owners used business checking (over 90 percent) followed by credit products such as revolving lines of credit (48 percent), fixed term financing (43 percent), business credit cards (37 percent), and international trade finance (1 percent). Transaction product use was much less frequent. Lockbox/night deposit was used by 23 percent, cash management services by 20 percent, bill payment by 11 percent, and receivables collection by only 2 percent of the respondents. The use of both credit and transaction products varied with size, years in business, industry and bank size. Credit product use showed a predictable relationship with firm size as owners of larger firms, in either sales or assets, more frequently reported their use. Those owners with faster growing firms more frequently reported the use of fixed term financing and revolving lines, but not seasonal borrowing. The relationship between years in business and credit product use was less clear. Although owners of the youngest firms (under five years in business) least frequently used credit products, the highest percentages of fixed term and revolving lines appeared among those in business between 11 and 25 years. Owners of ventures over 25 years old may have sufficient cash flow or may not be pursuing growth opportunities. Either reason reduces the need to obtain external financing. Industry effects were also evident in credit product use. Small-business owners in the agriculture and wholesale trade industries more frequently used seasonal financing, while those in manufacturing and transportation were heavier fixed term finance users. Owners in agriculture, construction, manufacturing and wholesale trade more frequently used revolving credit. 33 Credit, Banks and Small Business The New Century

41 Notable associations appeared between bank size and credit product use. Smaller banks tended to provide seasonal and fixed term financing more frequently while larger banks were more likely to provide revolving lines of credit. These outcomes were in part due to the association of firm size and industry with bank size. For example, larger firms that are more likely to use revolving lines of credit were more likely to be banking at larger institutions. Seasonal borrowing showed a strong association with industry, especially agriculture, construction, manufacturing, and wholesale, and these firms tended to more frequently bank at smaller institutions. Transaction product use also varied in significant ways with several firm characteristics. Business checking use increased with sales and assets. Lockbox/night depository showed little relationship to most firm characteristics, but was more frequently reported by those in the retail industry, particularly when using small banks. The need to deposit each day s sales receipts for retail firms is likely an important consideration. Business credit card use followed the patterns identified in Table 16 where larger firms more frequently used the product. Cash management and sweep accounts showed a use pattern similar to business credit cards. Owners of larger firms at larger banks more frequently used the service. This product tended to be less frequently used by the newest firms and most frequently by the oldest firms as well as by firms in the manufacturing, wholesale and FIRE industries. Finally, owners of the youngest, smallest firms that do business at small banks more frequently reported the use of bill payment services. TECHNOLOGY AND PRODUCT/SERVICE USE Since the 1995 survey, small-business owner use of technology for banking services has expanded, though probably less than envisioned by many bank marketing departments. Only 11 percent used the Internet for any of their banking (Table 20). Small-business owners might be expected to more frequently use the Internet if they currently do business with a larger bank or are further away from their primary institution. The former is more likely to occur because large banks have more resources to develop web-based applications and the latter because the Internet provides a lower transactions cost medium. However, the relationship between size of the current bank and Internet use was weak. Owners doing business at the smallest banks (under $100 million in assets) less frequently reported Internet use compared to those at the largest banks (over $20 billion), but differences were small. This finding suggests that the cost of entry into this dimension of banking is not prohibitive. Many banks can offer their services via the Internet and, on a computer monitor, all banks appear the same size. 34 Credit, Banks and Small Business The New Century The distance between the owner and the bank (as measured by time) might be expected to vary positively with use of the Internet for banking, but it did not. Nor was a noticeable relationship observable between the number of banks used and Internet use. Owners of larger firms, the youngest firms (perhaps the most technologically accomplished), and those in the FIRE industry where technology is an imperative for doing business, more frequently reported using the Internet for some banking services.

42 FINANCIAL SERVICE USE BY SELECTED FIRM CHARACTERISTICS Credit Products Transaction Products Lockbox/ Business Cash Fixed Revolv. Int l Business Night Credit Mgmt/ Bill Rec. Seasonal Term Line Trade 1 Checking Depository Card Sweep Payment Collection 1 All Firms 23% 43% 48% 1% 91% 23% 37% 20% 11% 2% Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, /3/03 10:10 AM Page 35 Sales Growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell

43 TABLE 19 CONTINUED Credit Products Transaction Products Lockbox/ Business Cash Fixed Revolv. Int l Business Night Credit Mgmt/ Bill Rec. Seasonal Term Line Trade 1 Checking Depository Card Sweep Payment Collection 1 Assets (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,001 $2, $2,001 $5, Over $5, /3/03 10:10 AM Page 36 Years in Business Over

44 Construction * Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE * Services Professional services Bank size Small (< $100 m) Mid ($100 $525m) Large ($525m $5b) Very Large ($5 $20b) Mega (>$20 b) /3/03 10:10 AM Page 37 Gender of Owner Male Female Both equally There are too few observations to make any meaningful comparisons across categories. *less than 0.5 percent

45 TABLE 20 INTERNET BANKING BY SELECTED BANK AND FIRM CHARACTERISTICS All Firms 1 11 Percent., Any Banking Via Internet Bank Size Small (< $100 m) 11 Mid ($100 $525m) 9 Large ($525m $5b) 13 Very Large ($5 $20b) 11 Mega (>$20 b) 11 Time to Bank <= 5 min min min min min min 6 Urban Location (MSA) Yes 12 No 8 Years in Business Over Credit, Banks and Small Business The New Century Sales (000s) Under $50 7 $51 $100 8 $101 $ $201 $ $501 $1,500 8 $1,501 $5, Over $5, Sales Growth (Annual avg. last 3 years) Declined more than 5 percent 10 No change 9 Grew 6 10 percent 12 Grew percent 15 Grew more than 20 percent 17 Too new to tell % reported none and 6% did not answer.

46 TABLE 20 CONTINUED Percent., Any Banking Via Internet Assets (000s) Under $50 11 $51 $ $101 $200 8 $201 $500 9 $501 $1,000 9 $1,001 $2, $2,001 $5, Over $5, Industry Agriculture 10 Construction 13 Manufacturing/Mining 13 Transportation/Comm. 8 Wholesale trade 11 Retail trade 8 FIRE 15 Services 12 Professional services 11 SERVICE AND RELATIONSHIPS Throughout the history of the Credit Banks and Small Business surveys, respondents have been asked to rate the importance of a set of characteristics that are central to their relationship with their major financial institution, and then to follow-up by assessing the performance of their primary financial institution on each of these same characteristics. The characteristics include location, providing helpful suggestions, accessibility of the loan officer, the range of services offered, speed of decisions, reliability as source of credit, knowledge of the owner s business and industry, knowledge of the local market, social contact with the loan officer, and the cost of money. Owners rated the importance of each characteristic on a scale of 1 ( Very important ) to 5 ( Not important ), and then their primary financial institution s performance on the same 5- point scale (1= Good, 5= Poor ). For comparative purposes, the importance and performance rankings are presented for the 2001, 1995 and 1987 surveys in Table 21 based on the frequency of top ( 1 ) ratings assigned to the characteristics in each survey year. 3 The only change of significance in the rankings of bank service importance between 1995 and 2001 was the increase from 39 percent to 49 percent in the percentage of owners that rate a convenient location as very important. This change may be in response to the loss of banks and branches as a result of banking consolidation. Fewer locations should be partially offset over time by gains in the technology of lending and the use of technology to provide more bank products and services. And, although the number of independent financial institutions has dramatically declined, the number of branches available has not. Thus, the degradation in convenience of location assessments appears to be a more complex issue than just geography. 3 The 1987 ratings are not perfectly comparable because a 3-point scale was used ( 1 = very important, 2 = important, 3 = not important), while a 5 point scale was used in 1995 and 2001 with the same headings (e.g., 1 = very important, 3 = useful, and 5 = not important). 39 Credit, Banks and Small Business The New Century

47 Consolidation of banks and merger activity probably resulted in the decline of two other performance measures. The top performance ratings for easy access to loan officer fell substantially from 45 percent in 1995 to 39 percent in 2001, as did performance evaluations for speed of decision, moving from 32 percent in 1995 to 28 percent in Some of the characteristics of the banking relationship are not important to many owners making a poor performance rating less consequential across the population. In the third panel of Table 21, performance reports are computed only for those who ranked a characteristic as very important (a 1 on the importance question). With this adjustment, conditional top bank performance showed a slightly different profile compared to the raw top rating, improving across six characteristics and declining over four from 1995 and improving across four and declining over six from The only top performance measures showing a consistent pattern of improvement over the last 15 years has been the cheapest money available, convenient location, and knows my industry. Over the same period, three top performance measures knows you and your business, speed of decisions, and access to the loan officer consistently declined. The increasing size of financial institutions appears to be the unifying theme in these trends. The top performance ratings showed a marked variation by bank market characteristics (Table 22). Mergers and competition had the expected effect on the top performance rankings. Mergers resulted in worse performance and more competition in better performance. For every characteristic except convenient location, owners experiencing a merger less frequently reported top performance rankings. The effect of more competition is equally clear. The percentage of owners giving top performance rankings was higher, usually by a large margin, for every one of the 11 dimensions of the relationship. The smallest differences were for provides helpful suggestions and convenient location. The largest differences, 16 percentage points or more between those reporting less competition for their business and those reporting more, were for reliable source of credit, knows you and your business, and speed of decisions. Market size and bank size also showed a strong association with the top performance ratings. Owners located in rural (non-msa) areas reported noticeably higher ratings for all characteristics except provides helpful suggestions, convenient location, and offers a wide range of services. Small banks performed better on every characteristic compared to their larger counterparts except for convenient location. The difference was most pronounced for mega-banks ($20 billion or more in assets). Larger banks with extensive branch networks must be offering better physical proximity than smaller banks with limited branches. 40 Credit, Banks and Small Business The New Century Account manager turnover was also strongly related to the performance ratings. This association highlights the importance of non-quantitative information and the value of the banking relationship. Firms experiencing no change in their account manager (one account manager in the last three years) more frequently reported top performance across all characteristics except for convenient location. Those who experienced three or more account managers less frequently reported top performance across every characteristic but one, convenient location. Small-business owners who reported that they shopped for a new bank less frequently reported good performance for all characteristics. This association between top performance ranking and tendency to look for a new bank was related to lower turnover in account managers for these owners. 4 Hereafter conditional top performance is referred to as top performance.

48 TABLE 21 PREFERENCES FOR AND DELIVERY OF SELECTED ATTRIBUTES OF FINANCIAL INSTITUTIONS Top Importance 1 Top Rating 2 Conditional Top Rating Offers cheapest money 48% 49% 49% 15% 13% 16% 13% 12% 11% Knows you and business Knows your industry Knows local market Social contact na na 11 9 na Provides helpful suggestions Convenient location Reliable source of credit Speed of decisions Easy access to loan officer Offers a wide range of services /3/03 10:10 AM Page 41 1 The percent of respondents who rated the characteristic as 1 in importance. 2 The percent of respondents that who the characteristic as 1 in performance. 3 The percent of respondents who rated the characteristic as 1 in importance and 1 in performance. na=not asked

49 TABLE 22 CONDITIONAL TOP PERFORMANCE BY SELECTED MARKET CHARACTERISTICS 1 Offers Knows Knows Knows Provides Reliable Easy Offers Cheapest You/Your Your Local Social Helpful Convenient Source Speed of Access to Wide Range Money Business Industry Market Contact Suggestions Location Credit Decisions Loan Officer of Services All Firms 13% 32% 13% 18% 11% 8% 36% 36% 22% 32% 16% Reported Merger/Acq /3/03 10:10 AM Page 42 Change in Competition More No change Less Urban Location (MSA) Yes No Bank size Small (< $100 m) Mid ($100 $525m) Large ($525m $5b) Very Large ($5 $20b)

50 Two Three or more Shopped for a New Bank The table shows the percent who rated importance as 1 and performance as 1. 3/3/03 10:10 AM Page 43

51 Performance rankings showed some relationship to firm characteristics (Table 23). Owners of larger, older firms more frequently gave higher top performance ratings for offers cheapest money available, knows you and your business, knows local market, reliable source of credit, speed of decisions, and easy access to loan officer. This outcome suggests that less risky firms rated bank performance higher, a conclusion that is supported by examining the outcome of the most recent loan application. For every characteristic, top ratings were associated with a lower frequency of denial on the most recent loan application. However, female-owned businesses reported noticeably higher top ratings compared to male-owned firms for knows you and your business, offers a wide range of services, and convenient location. Rankings of top performance were not lower than those for male-owned business for any of the characteristics. Strong industry effects were also apparent in the top performance ratings. Owners of agricultural firms gave the top performance ratings across all characteristics, except provides helpful suggestions and convenient location. The next highest industry ratings were given by transportation firm owners who rated banks highest on provides helpful suggestions and convenient location. 44 Credit, Banks and Small Business The New Century

52 CONDITIONAL TOP PERFORMANCE BY SELECTED FIRM CHARACTERISTICS 1 Offers Knows Knows Knows Provides Reliable Easy Offers Cheapest You/Your Your Local Social Helpful Convenient Source Speed of Access to Wide Range Money Business Industry Market Contact Suggestions Location Credit Decisions Loan Officer of Services All Firms 13% 32% 13% 18% 11% 8% 36% 36% 22% 32% 16% Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, /3/03 10:10 AM Page 45 Sales Growth Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell

53 TABLE 23 CONTINUED Offers Knows Knows Knows Provides Reliable Easy Offers Cheapest You/Your Your Local Social Helpful Convenient Source Speed of Access to Wide Range Money Business Industry Market Contact Suggestions Location Credit Decisions Loan Officer of Services Assets (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,001 $2, $2,001 $5, Over $5, /3/03 10:10 AM Page 46 Years in Business Over Denied on most recent

54 Construction Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE Services Professional services Gender of Owner Male Female Both equally /3/03 10:10 AM Page 47 1 The table shows the percent who rated importance as 1 and performance as 1.

55 CREDIT AVAILABILITY AND TERMS CREDIT SEARCH Seventy-seven (77) percent of the small-business owners (excluding the 13 percent who said they never tried to get a loan and the 10 percent who did not answer the question) searched for a loan at some time in their business history (Table 24). Most (63 percent) of the applicants applied for a loan in the 18-month period prior to the survey (2000 and 2001). Almost twothirds (65 percent) applied in person, but about 25 percent initiated their request over the phone (most likely those with stronger bank relationships) and 6 percent mailed or faxed in an application. Only 1 percent applied via the Internet. Technology, whether high-tech (e.g., the Internet) or low-tech (e.g., fax), was not an important channel for small firms to apply for loans. The most frequent loan purpose was for fixed assets financing (40 percent) followed by working capital needs (35 percent) and loan refinancing (9 percent). The median loan size requested was $60,000 and the average size was $240,000. The reason for the large difference between the average and median loan size can be seen in the frequency distribution. Thirty (30) percent of the requests were for $25,000 or less and 25 percent for more than $100,000, with nearly 10 percent for $500,000 or more. TABLE 24 LOAN APPLICATION EXPERIENCE Pct. of Those No. of Cases Raw Pct. Who Tried 48 Credit, Banks and Small Business The New Century Year of Last Attempt or before Never tried No answer Total % 100% Application Method In person Phone Mail/fax short form Internet web site No answer Did not apply Total % 100%

56 TABLE 24 CONTINUED Pct. of Those No. of Cases Raw Pct. Who Tried Loan/Credit Line Purpose Working capital Fixed assets Refinance/ Pay off existing loan No answer Did not apply Total % 100% Loan Size Requested (000s) $1 $ $11 $ $26 $ $51 $ $101 $ Over $ No answer Did not apply Total % 100% Mean Loan Requested (000s) $240 Median Loan Requested (000s) $60 1 Includes those who expressly did not try to obtain a loan and those who did not indicate whether or not they had. The profile of those owners who reported not trying to get a loan is shown in Table 25. The largest (over $5 million in sales) and smallest (under $50 thousand in sales) were less likely to report not applying for a loan, as were faster growing firms. Female-owned firms, firms doing business in the finance and insurance industry, and stable/declining firms were more likely to report never trying for a loan. These owners were also asked to report the reason for not trying to get a loan and could report multiple reasons. Of the total giving some reason, 75 percent indicated that they did not need the funds, while 15 percent reported that they never borrow, and 9 percent that they expected to be turned down. The respondents who expected to be turned down more frequently owned newer firms or were female owners. 49 Credit, Banks and Small Business The New Century

57 TABLE 25 NON-BORROWERS BY SELECTED FIRM CHARACTERISTICS No. of Cases Pct Did Not Try All Firms Reason (multiple responses allowed) Didn t need the funds Never borrow Expected turn down 48 9 Total % Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, Sales Growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell Credit, Banks and Small Business The New Century Industry Agriculture Construction Manufacturing/Mining 21 9 Transportation/Comm. 7 9 Wholesale trade Retail trade FIRE Services Professional services 22 17

58 TABLE 25 CONTINUED No. of Cases Pct Did Not Try. Years in Business Over Gender of Owner Male Female Both equally Over 70 percent of the applicants went to a bank for their loan, followed by six percent at credit unions and four percent at finance companies and other financial institutions (Table 26). Eighty-one (81) percent of owners seeking financing reported applying at only one financial institution compared to 75 percent in For those making only one application, 80 percent contacted a bank with the remainder spread over other institutions. When two applications were made, the bank share increased to 85 percent. Even when three or more applications were made, the bank share remained at 85 percent, while finance companies received 16 percent, 12 percent for other financial institutions, and 9 percent went to credit unions. Seventeen (17) percent of those applying at three or more places applied to private individuals (friends, relatives, other). TABLE 26 LOAN APPLICATION ACTIVITY No. of Cases Pct. of Total Pct.Who Applied Place Applied Bank Credit Union Finance Company Other Fin. Inst Friend, relatives Other individual Other No answer Did not apply Total % 100% 51 Credit, Banks and Small Business The New Century

59 TABLE 26 CONTINUED No. Pct.Who Pct.Who of Cases 2001 Pct. Applied 1995 Pct. Applied Institutions Applied One Two Three Four or more No answer Did not apply Total 100% 100% 100% 100% 100% Type of Lender Approached Finance Credit Other Fin. Friends, Other Bank Company Union Institution Relatives Individual Other Number of Loan Application Attempts One 80% Two 85% Three or more 85% Total Number of Attempts Includes those who expressly did not try to obtain a loan and those who did not indicate whether or not they had. 52 Credit, Banks and Small Business The New Century SUCCESS IN OBTAINING CREDIT Most owners were successful in finding a lender and obtaining credit (Table 27). Banks continued to be the predominant source of funds for 84 percent of the successful firms reporting an identifiable source, up slightly from 83 percent in 1995 and 76 percent in Seven percent (114 respondents) of the owners seeking a loan reported that during the past 3 years their application was turned down, possibly after repeated attempts. However, 184 owners reported a reason for a turndown. Clearly, some owners who were turned down at least once in their search for a loan did not answer the screening question, Where did you get your last loan? with the first option being, Did not get the loan. The incidence of turndowns was higher at 11 percent when measured as the number providing a reason for a refusal than the seven percent figure based on those reporting a turndown. Twenty (20) percent of those who had an application turned down were told the company was too new and had no track record. Twenty-six (26) percent had too much debt; 13 percent had, in the view of the lender, poor sales prospects or industry conditions; 9 percent had weak business financials; and, 10 percent had weak personal financials. The distribution of reasons given by lenders for loan refusals varies with economic conditions. Lenders in 1987 were much more concerned about a recession ( sales prospects ) than in 1995 as the economy began a 5- year period of above average growth. Twenty-six (26) percent of the refusal reasons were for sales prospects in 1987 compared to nine percent in 2001 and only seven percent in Leverage was more of a concern in 1987 and in 2001 compared to 1995 (29 percent and 26 percent of the reasons for a refusal in 1987 and 2001 compared to 18 percent in 1995).

60 TABLE 27 LOAN SEARCH OUTCOME 2001, 1995, AND 1987 Loan Source Pct. of Survey Year No. of Cases Raw Pct. Those Applying Turned down Approved Bank Credit Union Finance Company Other Fin. Inst Friend, relatives Other individual Other No source given Did not apply Total % 100% 100% 100% 100% Reason for Turndown Survey Year No. of Cases Pct. No. of Cases Pct. No. of Cases Pct. Too new Too much debt Poor sales outlook Poor industry conditions Weak personal credit history na na Weak business financial condition Other Total % % % Total applying Total approved (adjusted) Turndown rate (%) (adjusted) Total applying minus the total number reporting a reason for a turndown. 53 Credit, Banks and Small Business The New Century

61 Turndowns were least frequent for owners making only one application (Table 28). Those with one application reported a denial 7 percent of the time, those with three or more applications 41 percent of the time. No consistent relationship existed between turndowns and bank size. Applicants in MSAs and from owners whose legal form of business was a proprietorship, partnership or LLC experienced higher turndown rates, but this relationship is likely due to correlation with other risk factors such as years in business or industry. A clear relationship was evident between the length of time in business and the likelihood of a refusal. Twenty-two (22) percent of those who owned new firms (under 5 years in business) reported being turned down on the most recent attempt (compared to 11 percent of all firms overall). The turndown rate fell with increasing firm age and declined to 7 percent for those with firms in business 20 years or more. Turndown rates also varied widely by industry. They were lowest for service sector firms with 5 percent for professional service and FIRE and highest for those in transportation and communication (19 percent). Turndown rates also showed a strong negative association with firm size (sales, employment, assets) ranging from 16 percent for those with firms with under $50,000 in annual sales to 3 percent for those with firms of more than $5 million. In general, a higher leverage ratio (debt to equity ratio) and declining sales growth were associated with a higher turndown rate. Finally, turndown rates were much higher for female business owners (17 percent). However, this outcome was due to their firms being smaller, concentrated in the service industry, and in business fewer years than their male counter-parts. Controlling for firm differences erased the male/female turndown rate (not shown). TABLE 28 LOAN TURN DOWNS BY SELECTED APPLICATION AND FIRM CHARACTERISTICS No. Pct. of Cases Turned Down All Firms Credit, Banks and Small Business The New Century Where Applied Banks Finance Co Credit Union 66 8 Other Fin. Inst 70 8 Other (friend, etc) 96 5 Number of Attempts One Two Three or more Bank Size Small (< $100 m) Mid ($100 $525m) Large ($525m $5b) Very Large ($5 $20b) Mega (>$20 b)

62 TABLE 28 CONTINUED No. Pct. of Cases Turned Down Form of Business Proprietorship Partnership Corporation S-Corporation LLC Annual Sales (000s) Under $ $50 $ $100 $ $200 $ $500 $1, $1,500 $5, $5,000 or more Sales Growth (Annual avg. last 3 years) Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell Total Assets (000s) Under $ $ $ $ $ $1,000 $1, $2,000 $4, $5,000 or more 75 1 Liability/Asset Ratio No debt <20% % 40% Over 40% Credit, Banks and Small Business The New Century

63 TABLE 28 CONTINUED No. Pct. of Cases Turned Down Years in Business or more Industry Agriculture Construction Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE 99 5 Services Professional services Urban Location (MSA) Yes No Gender of Owner Male Female Both equally Credit, Banks and Small Business The New Century TERMS OF CREDIT The average loan size granted was $233,000 and the median size granted was $50,000. The average size received was $5,000 above the average loan size requested, while the median size received was $10,000 below the median loan size requested (Table 29). Forty-five (45) percent of the new loans made were fixed term loans; 27 percent were new or increased credit lines; 26 percent were a refinancing or renewal of existing loans; and 2 percent were new business credit cards (essentially a line of credit). Loan fees were reported by 26 percent of the borrowers; 17 percent indicated origination fees and 3 percent commitment fees for lines of credit. Thirty-one (31) percent were required to do their business checking at the lending institution and nine percent were required to do their personal banking at the lender as well. Fifty-two (52) percent of those receiving a new loan were required to post collateral as part of their loan agreement. Surprisingly, 21 percent of the owners reported collateral valued at over $1 million. The average collateral value was $667,000 with a median market value of $250,000.

64 TABLE 29 LOAN SIZE, TYPE, AND NON-PRICE TERMS FOR NEW LOANS RECEIVED Loan Received No. of Cases Pct. Of Total Loan Size (000s) $1 $ $11 $ $26 $ $51 $ $101 $ $500 or more No answer/turned down Turned down Did not apply Total % Mean size (000s) $233 Median size (000s) $50 Pct. Reporting No. of Cases Pct. of Total Loan Type Most Recent Loan Type NEW fixed term NEW line of credit INCREASED line of credit RENEWAL of existing loan NEW business credit card REFINANCING of an existing loan No answer/turned down Did not apply Total % 100% 57 Credit, Banks and Small Business The New Century

65 TABLE 29 CONTINUED No. of Cases Pct. Reporting New Loan Loan Requirements Personal Checking Business Checking Collateral Loan Fees Origination Fee (258) (19) Commitment Fee (40) (3) No answer (104) (7) No. of Cases Pct. of Total Pct. Reporting Collateral Value Collateral Amount (000s) $1 $ $20 $ $51 $ $101 $ $250 $ $501 $ Over $ No answer Total % 100% Mean Collateral Amount (000s) $667 Median Collateral Amount (000s) $ Credit, Banks and Small Business The New Century The incidence of collateral by type and fees by firm size and industry classification is shown in Table 30. Business property was most frequently used for collateral (64 percent) followed by inventory (36 percent). Accounts receivable were next most frequently reported (28 percent) along with personal guarantees not tied to non-business real estate (29 percent). Twenty-seven (27) percent used their homes or other personal real estate for collateral while 10 percent provided other personal assets. The use of accounts receivable as collateral rises with firm sales. In contrast, the use of the owner s private property generally declines with firm size (sales), while inventory shows no consistent pattern with firm size. Owners with the most marketable goods, that is to say, those in the wholesale and retail industry, most frequently reported using inventory as collateral. Wholesalers also most frequently reported using receivables as collateral. Owners of service firms most often put up their homes as collateral. Those in the FIRE industry most often put up other personal real estate. The percentage of owners reporting collateral requirements rose from 48 percent for the smallest (sales under $50,000) to 77 percent for those whose firms have $5 million or more in sales. The incidence of revenue-generating requirements generally increased with the size of the enterprise. Requirements for business checking at the lending bank rose from 31 percent among owners of the smallest firms to 47 percent of those among the largest. Personal checking business was required for 14 percent of the smallest (under $50,000 in sales) compared to 10 percent of the largest firms. The incidence of loan fees showed little relationship to firm size.

66 COLLATERAL AND OTHER LOAN REQUIREMENTS BY SELECTED FIRM CHARACTERISTICS Type of Collateral Taken Business Other Personal Other Personal Inventory Receivables Property Home Real Estate Personal Assets Guarantee All firms 36% 28% 64% 17% 10% 10% 29% Annual Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, /3/03 10:10 AM Page 59 Industry Agriculture Construction Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE Services Professional services

67 TABLE 30 CONTINUED Loan Requirements Collateral Business Personal Fees Checking Checking All Firms 63% 35% 10% 30% Annual Sales (000s) Under $ $51 $ $101 $ $201 $ $501 $1, $1,501 $5, Over $5, Industry Agriculture Construction Manufacturing/Mining Transportation/Comm Wholesale trade Retail trade FIRE Services Professional services Credit, Banks and Small Business The New Century PRICE OF CREDIT The survey period (1998 through 2001) covered a time frame of remarkable stability in longterm interest rates coupled with dramatic swings in short-term rates. The latter was precipitated by a major shift in Federal Reserve policy from trying to tame a rapidly growing economy (Federal Funds peaked at 6.5% in early 2000) to preventing a major recession (Federal Funds bottomed at 1.75% in late 2001). In spite of this, the average rate of interest on fixed rate loans was quite stable from year to year. This change in market conditions is reflected in the average rate for fixed rate loans reported by the date of the loan. The average rate for loans received in 2001 was 8.1 percent, higher at 8.4 percent in 2000, and 8.5 percent before The overall reduction in market interest rates between 1995 and 2001 is also reflected in the reported loan rates (Table 31). The average rate on fixed rate loans in 2001 was 8.3 percent compared to 9.4 percent in 1995 and 11.2 percent in The distribution of fixed rates paid showed substantial variation in 2001 with 12 percent paying under 6 percent and 23 percent paying over nine percent. These compare to less than 1 percent and 38 percent, respectively, for the same rate intervals in For owners with loans tied to the prime rate, the average spread was 1.3 percent and the median was 1.0 percent. Only eight percent of those with prime rate loans had a spread over 2.0 percent. The spread is down considerably from 1995, when the average was 1.7 percent and from 1987 where the average spread was 1.5 percent. The decline between 1995 and 2001 may reflect the increasing competition for small firm business or the slightly older profile of the respondents to this survey compared to the 1995 survey. Though not shown in Table 31, there was no meaningful difference in the average fixed rate paid by location, bank size, or the occurrence of a merger. Owners reporting more competition for their business paid lower rates, but this could be due to the risk characteristics of these firms (see Table 9).

68 TABLE 31 RATE PAID ON MOST RECENT LOAN Mean Median No. of Cases (Pct.) (Pct.) Interest rate Fixed rate Spread over prime Spread over LIBOR Spread over other 13 * * No answer 345 Did not apply/no source 638 Total 2223 Fixed Mean Rate (Pct.) Loan Year or earlier 8.5 No. of Cases Pct. of Total Fixed rate distribution <= 5.0% % % % % % % or more 69 9 Total % *too few cases to calculate 61 Credit, Banks and Small Business The New Century

69 TABLE 31 CONTINUED No. of Cases Pct. of Total Prime rate spread < 0% % % % % % >2.00% 37 8 Total % CONCLUSION What do the results of the 2001 edition of Credit, Banks and Small Business say about the state of small business financing and their owners relationships with their primary financial institution? Small-business owners generally were very successful in obtaining the credit needed to run their businesses, benefiting from the overall decline in interest rates and increased competition for their banking business since the last survey. Despite their success in acquiring credit, unhappiness with the quality of service was widespread, especially with staff quality and turnover. And, virtually all firms continued to experience fee increases for banking services used. Banks continued to be the dominant supplier of capital to small firms, accounting for 84 percent of the identified loan sources. Next largest in market share were finance companies accounting for 6 percent. All remaining credit sources accounted for only 10 percent of the loans granted. While banks were the largest supplier, smaller banks were the clear favorite of small firms. Large banks were rated uniformly lower on almost all characteristics important to a small firm s banking relationship. 62 Credit, Banks and Small Business The New Century Banking mergers had a mixed effect on small firms. Surprisingly, the occurrence of a merger did not have an effect on loan turndown rates, the average rate paid, or the incidence of collateral requirements. Although turndown rates were little different, owners of firms who reported mergers of their primary financial institution were also more likely to report that they were less able to meet all of their borrowing needs. Mergers had a strong, negative effect on fees and quality of service, with fees increasing in frequency and amount. Not surprisingly, small-business owners who did not switch banks after a merger were much more likely to actively shop for a new bank. Despite the continued pace of mergers in the banking industry, owners continued to report more competition for their business since This increase in competition resulted in a lower incidence of fees for services, improved credit availability, lower loan rates, and higher service quality, although even more competition did not prevent dissatisfaction with staff turnover.

70 The benefits of more competition were not distributed evenly across all small firms. Not surprisingly, larger, older firms had overall better experiences than smaller, younger firms. Femaleowned firms were less likely to use bank or trade credit and more likely to rely on credit cards. Yet, female owners did not rank their bank s performance on characteristics important to a banking relationship any worse than male-owned firms. While banks are the dominant provider of business loans, small firms relied on a variety of other sources of funds to finance their business. Both trade credit and credit cards were very important sources of financing. Credit cards were used by 84 percent of the respondents with 42 percent reporting outstanding balances. For those firms carrying balances, the average balance was almost $17,000, with a median balance of $4,000. The use of newer technologies for banking transactions, such as the Internet was very limited, concentrated mostly with newer firms whose owners may be more comfortable with this medium. Perhaps technology will become a more important part of interacting with banks in the future, but it is little used as of Credit, Banks and Small Business The New Century

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75 APPENDIX II TOTAL SAMPLE RESPONSE DISTRIBUTIONS 1. Over the last three years, was your firm able to satisfy its borrowing needs at all times? Percent No. of Cases Yes, all the time Yes, most of the time No, seldom satisfied needs Did not want or need to borrow No answer Over the last three years, have you noticed a change in the following characteristics of the financial institution you deal with most often: Better No Change Worse NA Total Accessibility of account manager % Quality of service % Number of services offered % Capability of staff, personnel % Staff turnover % Lending terms % Credit availability % Ease of doing your financial business % 3. During the last 4 years, was your principal financial institution merged or acquired by another? Percent No. of Cases 68 Credit, Banks and Small Business The New Century Yes, in Yes, in Yes, in Yes, in No No answer 4 87

76 Percent No. of Cases 3a. If YES, how did the change affect you? Positively, a good thing 2 46 No effect Minor transition problems Negatively, a bad thing Changed financial institutions 3 75 Too soon to judge 2 46 No answer 66 1, Over the last 12 months, has the number of services on which you pay fees: Decreased substantially? 1 20 Decreased slightly? 3 65 Stayed the same? Increased slightly? Increased substantially? Don t know No answer Over the last 12 months, have the fees per unit of service: Decreased substantially? 1 11 Decreased slightly? 3 68 Stayed the same? Increased slightly? Increased substantially? Don t know No answer a. If INCREASED, did the additional cost reflect a comparable increase in the quality of services received? Yes 2 45 No Don t know No answer Credit, Banks and Small Business The New Century

77 6. Please check each product/service that your business currently or recently (within the last 3 years) used at your primary financial institution. Yes No NA Total Seasonal financing % Night depository/lockbox % Business credit card % Cash management/ sweep account % Bill payment services % Fixed term financing (over 1 year) % Revolving line of credit % Business checking account % Receivables collection service % International trade financing % 7. Below are listed a number of characteristics that you might look for in a financial institution. How important is EACH one to you in conducting your firm s financial affairs? Very Not Important Useful Important NA Total Knows you and business % Provides helpful suggestions % Offers cheapest money available % Convenient location % Reliable source of credit % Knows your industry % Speed of decisions % Easy access to loan officer % Offers a wide range of services % Knows local market % Social contact % 70 Credit, Banks and Small Business The New Century

78 8. How would you rate YOUR PRINCIPAL FINANCIAL INSTITUTION on these same characteristics? Good Acceptable Poor NA Total Knows you and business % Provides helpful suggestions % Offers cheapest money available % Convenient location % Reliable source of credit % Knows your industry % Speed of decisions % Easy access to loan officer % Offers a wide range of services % Knows local market % Social contact % Percent No. of Cases 9. What is the approximate time it usually takes to go from your place of business to your financial institution? 5 minutes or less minutes minutes minutes minutes minutes or more 2 51 No answer We want to analyze bank performance as it related to the size of the bank. If you know the size of your principal financial institution in terms of assets, please check the appropriate category below. If you are not sure or don t know, please name your principal bank and we will look up the size. Under $50 million $50 to $100 million $100 to $999 million $1 to $4.9 billion $5 to $19.9 billion $20 to $100 billion $100 billion or more Don t use a bank, use another type 1 27 No answer Credit, Banks and Small Business The New Century

79 Percent No. of Cases 11. Have you noticed any change in the competition for your firm s financial business compared to 3 years ago? Much more competition Slightly more competition No change in competition Slightly less competition Much less competition 4 88 No answer Within the last 3 years, did you actively shop for a new financial institution? Yes No No answer a. If YES, why? (Check ALL that apply) (Percent of total in question #12 who selected each category) Turnover in account managers Needed more credit Wanted better loan terms Needed more services than offered 3 74 Lower interest rates Needed better service When is the last time you changed principal financial institutions? 72 Credit, Banks and Small Business The New Century Never changed or earlier No answer 7 154

80 Percent No. of Cases 13a. What was the major reason for changing? Problems with a merger Turnover in account managers 4 6 Inadequate credit line 4 85 Loan terms too difficult 3 69 Followed account manger to a new bank 4 84 Could not get desired loan terms/size Treated me as a stranger Other No answer b. At the time you changed, how did the size of your new bank compare to the one you left? Larger Smaller About the same size No answer How many account managers have you dealt with at your current principal financial institution in the past 3 years? None One Two Three Four or more 4 85 No answer Overall, how many BANKS does your firm use? None 1 31 One Two Three Four or more 3 75 No answer Credit, Banks and Small Business The New Century

81 Percent No. of Cases 15a. How many of the banks you use are in your local market? None 4 87 One Two Three Four or more No answer b. How many NON-BANK financial institutions (finance company, credit union etc.) does your firm use for loans, credit cards, lease financing etc.? None One Two Three Four or more No answer c. How many of these non-bank financial institutions are in your local market? None One Two 4 98 Three 2 45 Four or more 3 62 No answer d. Does your firm do any of its banking over the internet? 74 Credit, Banks and Small Business The New Century Yes No No answer 6 130

82 Percent No. of Cases 16. How many different BANKS (with different names) are you aware of in the market area in which your firm does most of its business? One Two Three Four Five Six Seven Eight to ten Eleven or more No answer In your last fiscal year, what were the TWO most important sources of funds to finance your WORKING CAPITAL needs? Bank loans (excluding credit cards) Credit cards Finance company loans Other loans (friends etc.) Trade credit (from suppliers) Earnings One source only No answer Total In your last fiscal year, what were the TWO most important sources of funds to finance CAPITAL OUTLAYS? Bank loans (excluding credit cards) Credit cards Finance company loans Other loans (friends etc.) Trade credit (from suppliers) Earnings One source only No capital expenditures No answer Total Credit, Banks and Small Business The New Century

83 Percent No. of Cases 19. Do you have one or more business loans outstanding (fixed term or line of credit)? Yes No No answer a. If YES, what is the approximate total amount currently owed on these loans? ($000s) , ,001 4, ,000 or more 1 15 No answer b. Have you renegotiated the terms on any of these loans within the last 3 years? Yes No No answer c. Have you had a business loan application denied anytime in the past 3 years? Yes No No answer Credit, Banks and Small Business The New Century 19d. How many different lenders do you currently use? One Two Three Four or more 4 83 No answer

84 Percent No. of Cases 20. Do you use credit cards for business purposes? Yes, card in business name Yes, personal card Both business and personal card No No answer a. If YES, what is the approximate total of all outstanding balances owed on these cards? ($000s) None or less or more No answer b. How many different business credit cards and accounts do you use? None One Two Three Four or more No answer Do you have existing accounts payable (not credit card debt) owed to your suppliers? Yes No No answer Credit, Banks and Small Business The New Century

85 Percent No. of Cases 21a. Estimate the percentage of your firm s purchases (dollars, not transactions) that are made on credit. None 3 59 Under 10% % 19% % 29% % 39% % 49% % 59% % 69% % 79% % 89% % or more No answer b. Estimate the percentage of your firm s purchases (dollars, not transactions) that have discounts for early payment. None (0%) % or less % 10% % 25% % 50% % 89% % or more 3 68 No answer c. How often do you take advantage of discounts for prompt payment when available? 78 Credit, Banks and Small Business The New Century Always Usually Rarely Never 4 87 No answer

86 Percent No. of Cases 22. What is your estimate of the RATIO of your total business liabilities to your total business assets? Zero (no debt, no answer) % % % % % % % or higher Do you have any PERSONAL loans (other than a personal credit card) that were used for business purposes? Yes No No answer a. Is the largest amount of your business s outstanding financial obligations in: Leases Credit cards Loans No answer When was the last time you TRIED to get a loan (fixed term, new or increased line of credit etc.)? or prior Never tried to get a loan No answer Credit, Banks and Small Business The New Century

87 Percent No. of Cases 24a. If you NEVER TRIED TO GET A LOAN, was it because (check all that apply): You didn t need the funds Never borrow 3 76 You expected to be turned down 2 48 No answer b. Where did you try to get your most recent loan and how did you apply? In person Phone Mail/Fax short form application Internet, web site 1 15 Total Bank Credit Union 4 72 Finance company Other financial institution 4 79 Friend, relatives 3 53 Other private individual 2 24 Other 2 36 Total c. From how many financial institutions did you TRY to get a loan before you were successful or stopped trying (including internet sources but excluding private individuals)? 80 Credit, Banks and Small Business The New Century One Two Three 3 56 Four 1 30 Five or more 1 30 No answer d. What was the purpose of the loan or credit line? Working capital Fixed assets (building, land, equipment, vehicles) Refinance/pay off existing loans Not applicable No answer 6 130

88 Percent No. of Cases 24e. What loan amount did you request? ($000s) 24f. Where did you get the loan? Over Did not Apply No answer Did not get the loan Bank Credit Union 2 33 Finance company 3 74 Other financial institution 2 43 Friend, relatives 1 21 Other private individual 1 17 Other 1 26 No answer g. If turned down, what was the reason given? Too new, no track record 2 37 Too much debt, too little equity 2 47 Outlook for sales, slow growth 1 17 Poor industry conditions/ prospects 1 7 Weak personal credit history 1 19 Weak business financial condition 1 16 Other 2 41 No answer Credit, Banks and Small Business The New Century

89 Percent No. of Cases 25. Was your most recent loan: A NEW fixed term loan A NEW line of credit An INCREASED line of credit A RENEWAL of an existing loan or line of credit A NEW business credit card 2 40 A REFINANCING of an existing loan No answer What was the size of your most recent loan (or line of credit, line increase, or credit card limit)? ($000s) 27. Pay back period (loan maturity)? , Over 1, No answer Credit, Banks and Small Business The New Century No loan, no answer months or less months months months months months over 120 months 6 126

90 Percent No. of Cases 28. What was the interest rate? Under 5% % 6% % 9% % 14% % or more 1 20 No answer 1 15 Fixed Rate Loan Total Prime(plus) LIBOR (plus) or other index 1 33 Variable Rate Loan Total No answer, no loan Converted Interest Rate Under 5% % 6% % 10% %-14% % or more 1 29 No answer Were you required to pay a fee for the loan? Yes No No answer a. If YES, was there an origination fee? Yes No No answer Credit, Banks and Small Business The New Century

91 Percent No. of Cases 29b. If YES, was there a commitment fee for the unused portion of the line? Yes 2 45 No No answer Was business and/or personal collateral required? Yes No No answer a. If YES, check all types of collateral that apply. Inventory Accounts receivable Business property/equipment Personal residence Other personal real estate 4 93 Other personal assets 4 94 Personal guarantee b What was the approximate market value of the collateral? ($000s) Under ,000 or more No answer Credit, Banks and Small Business The New Century 31. Was your business required to maintain a checking account or use other financial services at the lending institution to get the loan? Yes No No answer/not applicable

92 Percent No. of Cases 31a. Was your personal banking business required at the lending institution as a requirement of the loan? Yes No No answer/not applicable What is your legal form of business organization? Proprietorship Partnership 4 97 Corporation Sub-S corporation Limited liability corporation 4 81 No answer During your last fiscal year, what were your gross sales, net of sales taxes and other excise taxes? ($000s) Under , ,501 5, Over No answer Which category best describes the average annual change in your gross sales over the past 3 years? Declined more than 5 percent No change Grew 6 10 percent Grew percent Grew more than 20 percent Too new to tell 2 49 No answer Credit, Banks and Small Business The New Century

93 Percent No. of Cases 35. What category best describes the trend in profitability for your business over the past 3 years? Declined Basically unchanged Up less than 10 percent Up more than 10 percent No answer Do you rent, own or lease your business assets? Own Rent/Lease Both NA Total Buildings % Equipment % Vehicles % Percent No. of Cases 37. What category best describes the total asset value of your firm at the end of your last fiscal year? ($000s) 38. How long have you owned this business? Under ,000 1, ,000 4, ,000 or more 4 85 No answer Credit, Banks and Small Business The New Century Under 5 years Over No answer 4 104

94 Percent No. of Cases 38a. In what year was the business founded? Prior to No answer How many employees do you have including yourself? 40. Is the principal owner of this business: One or more 2 46 No answer Male Female Male and Female equally No answer 4 81 Industry Classification Construction Manufacturing Transportation 4 85 Agriculture Wholesale Retail FIRE Services Professional No answer Credit, Banks and Small Business The New Century

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