The Commercial Mortgage Loans Guide 

What Went Wrong with Small Business Financing?

by Stephen A. Bush

Business Financing Services

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. For many commercial borrowers, this is not a hypothetical issue at all, especially if they need help currently with small business finance options. 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. Nothing could be further from the truth. If small business owners and commercial lenders choose to ignore the many mistakes made by business lenders, as noted in a popular phrase we may be doomed to repeat these mistakes.

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 achieve higher-than-normal returns and quick profits. The only people seemingly surprised by the devastating losses are the bankers themselves. The largest small business lender in the United States (CIT Group) declared bankruptcy after two years of attempting to get someone else to pay for their mistakes. 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.

There were many instances in which banks failed to look at cash flow when making loans or buying securities such as those now referred to as toxic assets. 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. Lehman Brothers was one of the most aggressive commercial lenders using this approach, and they filed for bankruptcy last year due to this as well as other questionable financial practices.

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 commercial loans were made in which there was little or no equity by the business borrower. When buying the future toxic assets, banks themselves invested as little as three cents on the dollar. The apparent assumption was that if any downward fluctuation in value occurred, it would be a token three to five 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. In contrast to the government bailouts to banks having toxic assets based on non-performing residential loans, it is unlikely that banks will receive similar financial assistance to cover commercial mortgage problems. As a result, a realistic expectation is that such commercial finance losses could produce serious problems for many banks and other lenders over the next several years. As noted in the following paragraph, many lenders have already drastically reduced their small business finance programs.

Inaccurate and misleading statements by commercial lenders about their lending activities for business finance programs to small business owners is an ongoing problem. Although banks have typically been reporting that they are lending normally with their small business financing, the actual results indicate something very different by any objective standard. 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.

There are practical and realistic small business finance solutions available to business owners in spite of the inappropriate commercial lending practices just described. Due to the lingering impression by some that there are not significant commercial lending difficulties currently, the intentional emphasis here has been a focus on the problems rather than the solutions . As most independent and objective observers agree (despite views to the contrary by politicians and lenders), the series of mistakes made by commercial lenders were extremely serious and likely to be long-lasting for business borrowers.