Tracking small business lending in the Ninth District: What the new CRA data allows

The traditional image of the small businessperson trudging into the bank to submit her loan application and financial statements to the loan office may not hold in the future. Why? Firms have developed a statistically based process called credit scoring that allows lenders to evaluate financial data provided by third parties on firms and their owners. After this review, the lender determines which small firms pass their credit tests. The lender could then mail very brief, in some cases preapproved, loan applications to the select firms. (This process and its implications are discussed in more detail in "Small Business Loans, Small Banks and a Big Change in Technology Called Credit Scoring," The Region, Federal Reserve Bank of Minneapolis, September 1997.)

What is particularly novel about credit scoring small business loans is that it allows banks to underwrite small business loans in communities where they don't have a physical presence. As a result, there is reason to suspect that the rise of small business credit scoring would lead to more loans in communities from banks without a branch in that area.

But how would analysts be able to determine if such out-of-market lending is on the rise? Several years ago, there simply was no data to allow such a review. Analysis of small business bank lending was limited to the amount of outstanding loans reported on the balance sheets of banks and thrifts. Since 1996, however, banks and thrifts have had to report their own geographic location and the location of borrowers receiving small business loans in a given year. In this data, small loans to business-those under $1 million-are considered small business loans because surveys show that most small loans go to small firms. But, this data is not perfect. For example, the data does not capture loans made by finance companies. It also requires estimates of loans made by smaller institutions that do not report the data directly (for more details on the data itself, go to www.ffiec.gov). But, even with these warts, the data provides a first chance to gauge an important geographic aspect of small business lending in the Ninth District.

The basics of small business lending in the Ninth District

The following picture of small business lending in the Ninth District emerges from the most recent data (1997): $7.4 billion in small business loans were made in the Ninth District (excluding northwestern Wisconsin and the Upper Peninsula of Michigan). Loans made in Minnesota accounted for over 60 percent of small business lending, and the remainder was spread equally among Montana, North Dakota and South Dakota. Roughly a third of the loans fell into the smallest loan size demarcation of under $100,000, the category of loans most associated with very small firms.

Loans to the smallest firms are not equally distributed among all the banks in the district. The district's smallest banks, in particular, appear to have made a disproportionate share of business loans under $100,000. Banks with assets under $100 million originated roughly 39 percent of these small loans in 1997, even though they controlled only 17 percent of the banking assets in the district. Indeed, about 60 percent of the loans made by the small banks fell into the under $100,000 level in contrast to banks with assets over $1 billion that had 25 percent of their business loans in that category.

Spotlight on outsider loans

Analysis of the CRA data indicates that about 10 percent of the small business loans made in the Ninth District came from banks with no branches in the district. Utah is responsible for most of the out-of-district lending, with an affiliate of American Express accounting for almost 1 percent of the total small business loans made in the Ninth District (see table). The activity of a credit card issuer in this field is not surprising, as the new technologies used to make the small business loans have roots in credit card lending. In addition, Wells Fargo, a well-known user of the new small business technology, made about $30 million of the smallest business loans in the Ninth District in 1997.

Of course, the Ninth District is a fairly large definition of a market. While it is beyond the scope of this article, this data-along with clever computer programming-will allow analysts to determine how many loans made in Duluth, Minn., for example, were made by banks without a branch in that city but with branches in Minneapolis. This new data thus has implications for merger analysis. Government analysts are interested in knowing how a merger of two banks in the same market will affect the availability of credit to small firms in that market. Now analysts can consider this question knowing if local firms already received many of their bank loans from distant institutions.

In any case, the 1997 data creates a baseline against which we can evaluate big picture trends in outside market lending. The data will also allow for exploration of more narrow trends. Will, for example, the merger of Wells Fargo and Norwest increase the use of preapproved small business loan applications in the Ninth District? Only time and the new data will tell.