Thursday, June 08, 2017

Financing Post the Great Recession

Will U.S. small businesses be the main beneficiaries of increased competition in the lending space?

The crisis is long over but we are not out of the woods yet. Most indices are up although consumer confidence and spending have yet to reach pre-crisis levels. In fact, as of 2014, based on 100 financial crises going back to the 1890s, it took an average of eight years for real income per person to return to pre-crisis level. By comparison, just seven of the 12 countries where systemic crises began in 2007-08 managed to get back to at least their starting point.
Banks worldwide are not in the best of shapes either and that has implications for lending. As of May 2017, the S&P 500 banks index is down 30% from its peak in May 2007. By comparison, the STOXX Europe 600 index of bank share prices is down two-thirds from its peak in May 2007.
Still, small business lending in the United States is up on all levels, including SBA lending, conventional lending and alternative lending. 
Overall, in the United States, 5,400 community banks provide 43% of small business loans. These are relatively small operations as over 5,000 have less than $1 billion in assets and more than 1,500 less than $100 million.
On the face of it, community banks appear in good shape. Between March 2016 and March 2017, their loan books grew by 7.7%, more than twice the rate at other, mainly much bigger, lenders. However, net income rose by 10.4%, against 12.7% for the whole industry. Returns on equity, at 9.2%, were a little below the average.
And there are other market forces at work and there are certain trends that may to a shift to an increasingly changing landscape for U.S. small business lending. Since many community banks are very small, they are increasingly consolidating. Mergers and the aftermath of the financial crisis resulted in a drop of over 30% in the number of U.S. community banks between 2006 and 2016. Just between 2008 and 2012, more than 400 U.S. community banks failed and only four have opened since.
Going forward, they are facing additional challenges. For starters, finding talent will be increasingly difficult for banks as some graduation trends show. Between 2006 and 2016, finance as a graduate subject dropped from 31% to 15% at MIT's Sloan School and from 55% to 37% at Columbia. By comparison, technology increased from 12% to 33% at Stanford while doubling at other schools. Further, retaining talent will also be harder. A small community bank in the middle of nowhere is not as attractive as a big player in New York.
In addition, fulfilling their regulatory obligations is increasingly costly. Between 2011 - the year after the Dodd-Frank act regulations - and 2015, the number of people working directly on "controls" at the U.S. largest bank JPMorgan increased from 24,000 to 43,000. While a biggie like JPMorgan is able to absorb such costs, many small community banks will struggle more. The Trump administration has promised to cut through the red tape and reduce regulatory requirements. However, that may take years.
More importantly, regulations and mergers aside, community banks have to find ways to handle competition from a completely different set of players. Enter digitalisation and so-called fintech start-ups. As of 2017, about 20% of U.S. small businesses look to online lenders when seeking a loan. Regular lenders are trying to counter this with increased digitalisation and streamlining to reduce the costs of the lending process. Still, they will have to watch their backs as more and more fintechs enter the market. For instance, in 2016, peer-to-peer lending in the United States reached $19 billion on the country's biggest platform. In addition, between 2012 and 2016, U.S. Fintech investment grew from an estimated $2.5 billion to $6 billion, with a peak of just under $8 billion in 2014.
While the U.S. lending market may experience a few disruptions, there is little reason to believe that lending overall will be negatively impacted in the long run. Rather, increased competition and alternative sources of lending capital could actually be advantageous for borrowers.

Sources: AltFi Data, Autonomous Research, Business Schools, The Economist, FRANdata, Harvard University, Thomson Reuters, U.S. Federal Deposit Insurance


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