What Went Wrong with Commercial Lending

The process of finding what went wrong with commercial lending and small business financing is designed to help business owners avoid serious future problems with their working capital loans and commercial mortgages.

Small business owners will be more likely to avoid serious future business finance problems with working capital management and commercial real estate loans by exploring what went wrong with business financing and commercial lending. This is not a hypothetical issue for most commercial borrowers, particularly if they need help with determining practical small business finance choices that are available to them. Business owners should be prepared for the banks and bankers who caused the recent financial chaos to say that nothing has gone wrong with commercial lending and even if it did everything is back to normal. Most observers are increasingly skeptical of this viewpoint. There were serious mistakes made by commercial lenders, and to borrow a popular phrase, if small business owners and business lenders choose to ignore these mistakes, they are doomed to repeat them.

In evaluating the most serious business finance errors, massive greed is an inescapable theme among lending institutions. Negative results were unsurprisingly produced by an attempt to produce higher-than-normal returns and quick profits. The only people seemingly surprised by the devastating losses are the bankers themselves. After two years of trying unsuccessfully to get someone else to pay for their errors, the largest small business lender in the United States (CIT Group) recently declared bankruptcy. We are already seeing a record level of bank failures, and by most accounts many of the largest banks should have been allowed to fail but were instead supported by artificial government funding.

When making loans or buying securities such as those now referred to as toxic assets, there were many instances in which banks failed to look at cash flow. A stated income business loan underwriting process was used for some small business finance programs in which commercial borrower tax returns were not even obtained. One of the most prominent business lenders aggressively using this approach was Lehman Brothers (which filed for bankruptcy due to a number of questionable financial dealings).

Bankers obsessed with generating quick profits frequently lost sight of a basic investment principle that asset valuations can decrease quickly and do not always increase. Many business loans were finalized in which the commercial borrower had little or no equity at risk. When buying the future toxic assets, banks themselves invested as little as three cents on the dollar. The erroneous assumption by banks was that any downward change in value would be limited to about three percent. In fact we have now seen many commercial real estate values decrease by 40 to 50 percent during the past two years. Commercial real estate is proving to be the next toxic asset on their balance sheets for the many banks which made the original commercial mortgages on such business properties. While there were huge government bailouts to banks which have toxic assets based on residential mortgages, it is not likely that banks will receive financial assistance to cover commercial real estate loan losses. Such commercial real estate financing losses could produce serious problems for banks and other lenders over the three years. Much to the dismay of all business owners and as mentioned in the next paragraph, many commercial lending programs have already been dramatically reduced.

A current and ongoing problem is represented by misleading and inaccurate statements by business lenders about their lending activities which include small business loans to business owners. While many banks have reported that they are continuing normally with small business finance programs, by almost any standard the actual results indicate something very different. From a public relations viewpoint, it is clear that banks would rather not admit publicly that they are not lending normally. Business owners will need to be skeptical and cautious in their efforts to secure small business financing because of this particular issue alone.

In spite of the questionable commercial banking practices illustrated above, there are some realistic and practical business financing solutions available to small business owners. The emphasis here is focusing on the problems rather than the solutions primarily because of the lingering notion by some that there are not significant current commercial lending problems. Most objective observers (which do not include politicians and lenders) are almost unanimous that the series of errors made by business lenders are likely to be long-lasting for business borrowers in their ongoing efforts to obtain small business financing.

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