Experts evaluate current banking trends

McDuff: Most loan requests have been centered in real estate (refinancing
and acquisition) and to a lesser extent lines of credit for working capital.
There have been limited requests strictly for capital goods. It is frequently
commented that there is a pent-up demand for capital goods expenditures once
the economy improves, which may bode well for the future.

Scala: We have seen only a modest pickup in capital investments year
to date. Given the economic malaise, which has been compounded by the Iraqi
conflict, business owners have been hesitant to commit to any significant capital
investment plans. The soft economy has resulted in plenty of excess capacity
in the system and thus capital investment is not widespread. We are seeing a
pickup in working capital financing as companies seem to be utilizing bank loans
to support inventory buildups in anticipation of the economy gaining some momentum
later in the year.

MarcAurele: I think there is evidence that they are spending. Although,
generally speaking, most businesses are cautious. Small businesses are making
capital investments based on solid orders that would support that investment.

Kelly: Because of the nature of our customers – this is a resort area,
more or less – our commercial lending has been fairly steady for years and is
actually growing in the past two years. In the small-business sector, there
has been some weakness – that’s an ongoing issue when you’re in a resort area.
But it has still been pretty strong.

What types of businesses are seeking loans and expanding during this economy?

Scala: Well-managed companies that have built a strong balance sheet
over the past few years are generally those that are surviving and borrowing
in this soft economic environment. These companies have cut expenses and reduced
debt levels, which has lowered their break-even points, making them more profitable.
In addition, they are working hard to quicken their cash conversion cycle which
appears to be significantly improving their cash flow. We have seen loan demand
from manufacturers and distributors that have diversified sales bases or products
that give their customers a technological edge or improved productivity. We
are also seeing loan demand from select service companies that have found a
niche market for their capabilities.

MarcAurele: There are two types of companies. The first type would
be companies that sell to a diverse market. In other words, a market that is
not just located in the United States, but internationally, where there is an
opportunity to take advantage of an economy that might be in a little better
condition. The other type of companies that are doing well are ones with niche
markets. They are companies with one or more unique products that retailers
or other customers cannot do without.

McDuff: In terms of industry concentration, loan demand has been spread
across the board. The security industry appears to have benefited from all of
the recent uncertainty. Success in the current economic environment seems to
be based more on a market niche or strong management coupled with a historically
strong financial condition.

Kelly: Again, our commercial lending is up across the board. But I
would say businesses connected to commercial real estate and construction –
those have been fairly strong.

What are your bank’s delinquency rates looking like over the last two to
three quarters? How do you address the losses?

Kelly: Our delinquency rates have been historically, extraordinarily
low – far below the national average, almost nonexistent. When reasonable delinquency
rates are 2 percent, we are consistently under 1 percent, and at times under
a half percent, or less. And that has at least partly to do with the strong
underwriting policies of those loans to begin with.

McDuff: Delinquencies have not been a problem at Freedom.

Scala: We are seeing that delinquency rates locally have been modest
and not really an issue at this point. We work with customers individually,
case by case to address any delinquency situations.

MarcAurele: Quite frankly delinquency rates have been minimal. They
are not any different than what we experienced before the economic slowdown.
Losses have been relatively small. The reasons for that is that going into a
flattened economy most customers were not over-leveraged and did not have a
high level of debt. Because of that, companies have been able to withstand the
slowdown.

We hear complaints from minority small-business owners about a lack of
funding sources. Does your bank have a program in place that targets minority
small businesses?

MarcAurele: We have been the leading Small Business Administration
lender for nine consecutive years (in Rhode Island). We have been a leader in
New England for the last couple of years. We have also been the leader in women-
and minority-owned business lending in Rhode Island. We have not heard complaints
about access to capital from our customer base. There is a lot available here.
We use the SBA program to help anyone start a new business. The program is a
good vehicle to make that happen.

Scala: Minority small businesses in Rhode Island never fail to amaze
me with their drive, determination, hard work and entrepreneurial spirit. Our
Fleet relationship managers have many resources available to them, both internally
and through the state’s economic agencies, to support a diverse array of small
businesses. In fact, Fleet has a dedicated unit of the company called the Community
Investment Group whose mission in part is to work with businesses in the communities
that are considered historically underserved. We also tap into the community
resources available to meet the needs of these businesses including working
very closely with the Minority Investment Development Corp. (MIDC) in providing
funding for borrowers who are not bankable but will be in the next two to three
years. We also actively utilize all SBA programs including the SBA Community
Express program which provides business planning and ongoing technical assistance
to the borrower following loan closing. Other business partners include PEDC,
Ocean State Business Development Corp. (the 504 program) and the Rhode Island
Economic Development Corp.

McDuff: Freedom places great emphasis on the customers and prospects
in our market area having direct access to decision-makers. This affords the
loan applicant the opportunity for direct communication, feedback and advice.
This also allows for flexibility in structuring loans to meet the customers’
needs, including the use of the various credit enhancement programs available.

Kelly: We hear complaints from minority small-business owners about
a lack of funding sources. Does your bank have a program in place that targets
minority small businesses?

I guess the answer to that is no, only because we don’t have any significant demand. There are just not that many minority small businessmen on Aquidneck Island, in particular. But we’re always on the lookout for opportunities to help the less privileged.

What kind of impact did the war have on the small-business community? And
what are you seeing happen since the end of the war?

Scala: The war has had an impact on small businesses primarily because
it continued to distort economic clarity. With an uncertain economic climate,
where supply has outpaced demand, business investment in capital spending has
been deferred. Companies that supply this part of the economic engine have been
hurt, as capacity utilization is way down, which generally reduces margins and
thus profits. Tourism has been impacted as well, both from the war and its effect
on escalation in terrorism and SARS. Airlines, hotels, car rental companies
and restaurants are impacted as fewer people are traveling and spending money.
From an indirect standpoint, small businesses have suffered the trickle-down
effect of corporations who have downsized, feeling an impact on their revenues.

Since the end of the war, people still have a wait-and-see attitude. The SARS epidemic has not helped and the economy remains weak. Real GDP growth has been very low and it doesn’t look like it’s going to get much stronger anytime soon. Interest rates remain at historically low levels, which is a good thing for both businesses and consumers alike. Rates will probably not move much within the next 12 months, as a stalled economy will keep them low.

Certain businesses are utilizing the low interest rate and product-pricing
environment to upgrade their systems or equipment provided the return on investment
is within their parameters. These businesses are taking out term loans and are
financing them over a three- to five-year period at historically low interest
rates. When the economy turns, these companies will be best poised to realize
the benefits.

MarcAurele: An obvious impact of the war has been on small-business
owners who are actually deployed in the war and are overseas. There was a short-term
management gap, which obviously has an effect. We have tried to help these companies
in terms of being flexible. Also, the war brought on more cautious spending,
generally speaking. Since the conclusion of the war, the mood has been more
optimistic to the extent of what has happened on the stock market, which has
had a trickle-down effect on small-business owners and consumers.

McDuff: The war had a negative impact on the economy in general, which
adversely impacted all businesses. Other than specific industries such as travel-related
companies, the impact was not overwhelming due to the war’s short duration.
I think the negative impact of the war was largely psychological with the real
issue being the inherent problems with the economy itself.

Kelly: I don’t think it had any effect that I can see yet. I can’t
see any discernable impact one way or the other.

What are the main factors you look at when considering a small-business
loan? How important is it for a business to have a business plan in hand?

MarcAurele: There are three primary areas. The first is a sound business
plan. The second is the experience of management; we’re looking for people who
have in fact done this business before or something related. The third thing
we look for is companies with sufficient capital to complete the plan as stated.
We try to help people and guide them in that regard. We want to put them in
a position, a financial structure, including equity and debt, that makes them
capable of sustaining the startup phase and until they can achieve profitability.

McDuff: The primary factor in judging a loan is a demonstrated ability
to repay the loan. This is followed by balance sheet strength, collateral, strength
of management and industry trend. A business plan is always important, with
the depth of the plan being a function of how great a departure the plan is
from historical operating patterns.

Kelly: It’s always important to have a business plan, because the turnover
and failure rate in small business is extra high. I’m a longtime commercial
lender myself – that’s my background – and I know from experience that lack
of management and planning skills is one of the biggest reasons for that high
rate of failure. The number one reason is insufficient capital from the outset
to sustain a business during setbacks in the first years. Good ideas do not
make good companies. It’s about analyzing competition and making sure you understand
what you’re up against. And you can’t baby-sit a businessman and run a business
for them on small-business lending. There’s only so much you can do economically.

Scala: We look at four key factors, not necessarily in this order:
Is the business viable? Is the management team strong? What is the loan being
used for? How will the company pay us back? Clearly the character and ability
of a company’s management is a key component as the people drive the business.
However, a business has to have a viable market for its products and services.
We need to understand what the loan is being used for. If the loan is going
for working capital or capital investment, fine. If it were to pay an environmental
liability, we would have to do more due diligence to become comfortable with
the situation. Finally, we need to do an analysis of how the bank is going to
be paid back and this is where the importance of a business plan comes into
place.

Business plans are critical and provide primarily the business owners and then its bankers with a strategic map of the past and future. They should outline the business, management, competition, opportunities, challenges and future performance. A well thought out plan articulates management’s strategy and concerns, and should forecast future results. It provides the basis for due diligence by the bank, helping us understand the company’s strategy, management’s vision and business dynamics before a credit decision is reached. The more we know about a company, regardless of size, the more we can provide value-added solutions.

Providence Business News staff writers David Ortiz, Laura Ricketson, Patricia
Resende and Managing Editor David Levesque contributed to this story.