Get Ready for Small Biz Stim

Reuters reports that the U.S. Treasury will soon launch a new program aimed at aiding small business lending, the head of the Treasury's $700 billion bailout fund said on Thursday. Herbert Allison, the Treasury's assistant secretary for financial stability, declined to provide details or specific timing on the program in testimony before the U.S. Senate Banking Committee.

The US Treasury has focused for the past year on stabilizing the banks with massive capital infusions into the sector with the TARP program. The TARP seems to have succeeded in its goal to shore up the economic capital base of bank's but lending activity to small and mid-size enterprises (SME) has dramatically slowed. Capital constraints and heightened risk aversion by commercial banks has curtailed access to moderately priced credit products for many SMEs. Credit risk aversion and the recession has hurt the sector and has contributed to growing bankruptcy rates by capital starved SMEs.

SMEs employ more workers then any other business sector demographic. One of the reasons the recession has been so severe is due to the massive layoffs and business closures within the by SME segment. There are approximately 6 million SMEs in the United States. If each SME hired one person that would put a serious dent in the unemployment rate.

Some statistics on the SME demographic includes:

• Represent 99.7 percent of all employer firms.
• Employ half of all private sector employees.
• Pay more than 45 percent of total U.S. private payroll.
• Have generated 60 to 80 percent of net new jobs annually over the last decade.
• Create more than 50 percent of non-farm private gross domestic product (GDP).
• Supplied more than 23 percent of the total value of federal prime contracts in FY 2005.
• Produce 13 to 14 times more patents per employee than large patenting firms.
• Are employers of 41 percent of high tech workers (such as scientists, engineers, and computer workers).
• Are 53 percent home-based and 3 percent franchises.
• Made up 97 percent of all identified exporters and produced 28.6 percent of the known export value in FY 2004.

(Source: Cornell School of Industrial and Labor Relations, Basesky and Sweeney)

The US Treasury program will target the SME segment and direct capital to help lead the economic recovery. SMEs are the leading source of job creation, product innovation and wealth creation. A vibrant and financially healthy SME sector is key to any sustainable economic recovery. This program will also help to bolster the ailing community banking sector that has seen over 95 closures by the FDIC this year.

It is critical that SMEs prepare to participate in this program. Sum2 offers a complete product suite to help SMEs capitalize on the many opportunities economic recovery will present. Sum2's recently announced webinar series "Recovery Tools for a New Economy" offers SME critical management tools to profit from the emerging business cycle.

As the lending program to SME rolls out, bankers will initiate engagement process and business reviews. They will be looking to determine if SME managers have identified risks confronting their business. It is incumbent on small business managers to understand how changing market dynamics and operational risk factors are impacting their business and demonstrate how they will mitigate these risk factors.

Sum2 provides a series of risk assessment products that assist companies to chart paths to profitability and growth. The Profit|Optimizer, is a unique risk management and opportunity discovery tool that helps SMEs effectively manage the challenges posed by the recession and recovery business cycles.

Risk: SME, recession, recovery, stimulus, commercial banking

$700 Billion is a lot of Guacamole!

An article in today's Forbes online entitled Trouble with TARP, reports a growing concern by the Congressional Oversight Panel (COP) about the effectiveness of the $700 billion program. The COP reports that the effectiveness of the program is difficult to determine due to lack of transparency of how funds were spent. The COP report also states that the absence of any reporting guidelines for TARP participants impedes effective oversight.

The 145 page report starts with a retelling of the extreme conditions confronting the banking sector as the credit crisis exploded last autumn. It also outlines the choices confronting regulators, legislators and industry executives as the crisis deepened. We were led to believe by Treasury and Federal Reserve officials that the global banking system was in imminent danger of collapse. Nothing less then immediate and drastic measures taken by sovereign government officials and industry executives would prevent the catastrophic consequences of global economic carnage. The report makes it clear that these market conditions were so extreme that regulators were navigating through uncharted waters. Any remediation measures taken had little historical precedence to guide actions. Hence Paulson was given carte blanche to handle the crisis with unprecedented latitude and executive facility.

As this blog reported earlier this week, the TARP was originally designed to acquire troubled assets from banking institutions. TARP funds were earmarked to purchase mortgage backed securities and other derivatives whose distressed valuations severely eroded capital ratios and stressed banks balance sheets. Hank Paulson later shifted the strategy and decided to inject TARP funds into the banks equity base. This has done wonders for the shareholders of the banks but troubled assets remain on the banks balance sheet. As the recession continues, unemployment, home foreclosures, SME bankruptcies and the looming problem with commercial mortgage backed securities (CMBS) are placing a new round of added strain on the banking system.

The TALF program is designed to draw private money into partnership with the government to acquire troubled assets from banks. So far the program has received a tepid response. I suspect that the principal factors inhibiting the expansion of the TALF program are numerous. Chief among them is the inability of FASB to decide upon valuation guidelines of Level III Assets. Banks holding distressed securities may also be reluctant to part with these assets because they have tremendous upside potential as the economy improves.

The COP also questioned the effectiveness of TARP because stress tests were only conducted on 19 banks. The report states that additional stress tests may be required because the previous tests failed to account for the length and depth and length of the recession. Community banks are also of concern. They face a perfect storm in challenging macroeconomic conditions. Of particular concern is commercial real estate loans. Many economists are concerned that high rate of loan defaults in commercial loan portfolios pose great threats to the community banking sector.

Though interest rates remain low due to the actions of the Federal Reserve, lending by banks still remains weak. SME's are capital starved and bankruptcy rates are quickly rising. SME's are critical to any economic recovery scenario. A strong SME sector is also crucial for a vibrant and profitable banking system. Perhaps a second round of TARP funding may be required to get more credit flowing to SME's. If banks start failing again it would be devastating. The Treasury and the Federal Reserve don't have many bullets left to fire because of all the previous expenditures and a waning political will of the people to continue to fund a systemically damaged banking system.

Risk: banks, SME, economy, credit, market

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Waiting for the Other Shoe to Drop

According to a recently published report by a Congressional Oversight Panel reviewing the effectiveness of the Troubled Asset Relief Program (TARP), many banks remain vulnerable due to questionable commercial loans still held on their balance sheets. This is a looming problem for community and smaller banking institutions. Smaller banks are being adversely effected by the the rise of commercial loan defaults. Many community banks have large loan exposures to shopping malls and other small businesses hard hit by the recession.

The report states, "Owners of shopping malls, hotels and offices have been defaulting on their loans at an alarming rate, and the commercial real estate market isn't expected to hit bottom for three more years, industry experts have warned. Delinquency rates on commercial loans have doubled in the past year to 7 percent as more companies downsize and retailers close their doors, according to the Federal Reserve.

The commercial real estate market's fortunes are tied closely to the economy, especially unemployment, which registered 9.4 percent last month. As people lose their jobs, or have their hours reduced, they cut back on spending, which hurts retailers, and take fewer trips, affecting hotels."

Defaults in sub prime and other residential mortgages precipitated last years banking and credit crisis. The TARP program succeeded in stabilizing a banking system that was teetering on collapse. The $700bn infusion into the banking system appears to have buttressed depleted capital ratios and severely stressed balance sheets of large banking institutions. But many banks are still carrying troubled assets on their balance sheets. Commercial Mortgage Backed Securities (CMBS) values are tied to the cash flows generated by renters and lessors of the underlying mortgaged properties. As occupancy rates of commercial properties fall cash flows dissipate. The market value of these securities plummets creating a distressed condition. This places additional strain on the banks balance sheet driving capital ratios lower and places a banks liquidity and ability to lend at risk.

The TALF (Term Asset Backed Loan Facility) was instituted in March to extend $200bn in credit to buy side financial institutions to purchase troubled assets and remove them from banks balance sheets. So far only $30bn has been allocated through the program. Clearly banks balance sheets remain at risk due to their continued high exposure to this asset class.

A strong economic recovery will address this problem. A prolonged recession will resurrect the banking and credit crisis we experienced last autumn. It would appear that TARP II may be a necessity if more private sector investors don't step up to the plate and participate in TALF.

Risk: CMBS, commercial real estate, banks, credit risk

Drivers Wanted!

The cash for clunkers rebate program looks like it is a great success. The first $2. bn allotted to the program was used up within two weeks. The recently approved additional allocation of $1. bn for the program will no doubt be taken advantage of by consumers. American's always keen to do a deal and can't wait to drive away in a brand new ride unwritten in part by our most favorite relative, Uncle Sam.

The government's goals of the cash for clunkers program are being achieved. The program will have a positive environmental impact as more fuel efficient vehicles replace the old gas guzzling clunkers. The program has also allowed car manufacturers to liquidate 2009 inventories that were piled high due to tepid demand borne from the recession and credit crisis. The program may also help cure consumers recession psychology and their new found aversion to purchasing new stuff.

It is hoped that this boost to car manufacturers may kick start the economy. Ford Motor Company's recent positive earnings announcement and GMs and Chrysler's arrest of declining quarterly sales are one of the "green shoots" of recovery pointed to by politicians and economists. However a huge question remains concerning how to incubate long term sustainable drivers that will end the recession? The $600 tax rebate checks sent out by Paulson last year provided a temporary boost to the economy. Its effects did little more the forestalling the more deleterious effects of the growing recession. See The Charge of the Light Brigade. Hopefully cash for clunkers will help to kick start some recovery momentum to an economy aching for relief from systemic malaise.

The US economy has grown overly dependent on a few industry sectors that include services, real estate, banking and construction. The SME service sectors have been devastated by the contraction of credit, unemployment and the curtailment of consumer demand brought on by the recession. During the good times, these sectors were driving economic growth and expansion. Unfortunately these sectors remain conspicuously absent as leading drivers in the new emerging economy. Macroeconomic factors unpinning recovery continue to be negative for these sectors. Hi tech and manufacturing seen as critical to a lasting recovery have also been a bit lethargic. These industries are capital intensive and with the capital markets still seeking a firm recovery footing these sectors will remain weak. Health care and pharmaceuticals are key sectors in the US economy, but political uncertainty around reforming industry practices and much needed restructuring hampers the sectors ability to assume a leading position in recovery scenarios.

Last year Sum2 published The Hamilton Plan, a Ten Point Program to incubate small midsized enterprise (SME) manufacturers. At its core, the plan seeks to encourage capital formation initiatives from public and private sources. Manufacturing is key to any sustainable economic recovery. Our ability and desire to link manufacturing to the entrepreneurial capabilities and business skills of SME's to address targeted needs could well be the drivers that finally steer us out of the recession.

Risk: recession, SME, manufacturing

Job Loss Decelerating?

ADP has released its National Employment Report for July reporting a 371,000 decrease in non-farm private sector jobs. ADP has also revised its numbers for May from a decline of 473,000 to a decline of 463,000.

The ADP report states, July’s employment decline was the smallest since October of 2008. As a trailing economic indicator, unemployment is expected to continue to rise for the next few months. As the recession recedes and the economic recovery takes hold employment is likely to decline for at least several more months, albeit at a diminishing rate.

Highlights of the report include:

The report estimates non-farm private employment in the service-providing sector fell by 202,000.

Employment in the goods-producing sector declined 169,000, with employment in the manufacturing sector dropping 99,000, its smallest monthly decline since September of 2008.

Large businesses, defined as those with 500 or more workers, saw employment decline by 74,000, while medium-size businesses with between 50 and 499 workers declined 159,000.

Employment among small-size businesses, defined as those with fewer than 50 workers, declined 138,000. Since reaching peak employment in January 2008, small-size businesses have shed nearly 2.4 million jobs.

In June, construction employment dropped 64,000. This was its thirtieth consecutive monthly decline, and brings the total decline in construction jobs since the peak in January 2007 to 1,483,000.

Employment in the financial services sector dropped 26,000, the twentieth consecutive monthly decline.

The full report can be accessed here: ADP National Employment Report

Risk: unemployment, recession

High Unemployment Spurs SME Bankruptcies

Two news items concerning the health of of the United States economy crossed my desk today. This morning ADP published its monthly National Employment Report for June. ADP announced that nonfarm private employment decreased 473,000 from May to June 2009 on a seasonally adjusted basis. Monthly employment losses in April, May, and June averaged 492,000. That equates to over 1.5 million jobs that were lost over the past 90 days.

The trend indicates that the rate of job losses is slowing; but the massive evaporation of jobs represents a serious erosion in buying power. The United States is a highly developed consumer oriented economy that is highly dependent on the discretionary buying power of consumers. Significant loss of jobs and the severe contraction of credit availability are severe headwinds that the US economy must overcome.

In recent years US job growth was fueled by small and mid-size enterprises (SME). Home based companies, specialty retailers and service oriented companies has fueled economic expansion and job growth. No more. The trend has been decidedly reversed due to the evaporation of consumer buying power, credit and capital constraints and other macroeconomic factors that conspire against the limited balance sheets of SMEs.

The USA Today reports, “The first five months of this year have shown a 52% increase in the total number of commercial bankruptcy filings (36,106) compared with the same period last year (23,829), according to the Automated Access to Court Electronic Records. On average thus far in 2009, some 350 commercial enterprises file for bankruptcy daily — an increase of 240% from 2006.”

The two attributes that distinguish the US economic colossus are the work ethic of its people and a deep abiding commitment and belief in a entrepreneurial culture that rewards hard work and risk. It would seem that these two virtues are under siege and are being stressed to a breaking point due to the depth and pervasiveness of the global recession. One thing is clear, the indomitable spirit of the American people are being put to the test. In time this great nation of great people will rise to meet and surmount the challenges posed by this great recession. It remains to be seen however how this will change the spirit and character of the American psyche and how future generations of countrymen will view the generations that left them with a debt laden legacy.

You Tube Music Video: George Gershwin, Three Preludes, #2

Risk: work ethic, entrepreneurial spirit, economic recovery, depression

New American Keiretsus

As the current challenging conditions in the credit markets continue its impact is having a profound impact on the community banking sector.
 

During the late '90s community banks control of the small mid-size enterprise (SME) market began to erode. The dynamics of the banking industry were rapidly changing. Larger banks leveraged operational and balance sheet scale and securitization to provide access to inexpensive credit products bundled with cash management tools. They were armed with huge marketing budgets and became adept at selling a growing array of transaction services that met the growing sophistication and business needs of the lucrative SME market. The current banking crisis forebodes yet another drastic alteration in the structure, regulatory and business practices of the industry. The current banking crisis will forever alter the face and scope of the community banking sector.

The challenge for the community bank will be to reinvent itself. A community bank must decide who its customers are and what its target market is. It must recognize its strength by leveraging its natural geographic advantages while selling products into markets that transcend geographic limitations. Community banks can accomplish this by selling products that address select segments.

What type of products will it take to be an effective SME bank? Products that help SME to manage cash flow and liquidity, make informed decisions on capital allocation initiatives, decrease the cost of capital, and facilitate transactions and new customer acquisition.

Community banks must begin to farm and align itself with new liquidity pools. Securing funding sources in a world of limited liquidity will be the greatest challenge for community banks. Overcoming regulatory hurdles notwithstanding, branding a community bank as a consistent, trusted and efficient delivery channel of credit products will be key to its survival. The community bank must recognize how it adds value in a complex and expanding delivery chain. The failure to secure funding sources will only accelerate balance sheet erosion resulting in merging with another institution or liquidation.As banking regulation evolves and private equity firms take larger stakes in the industry section interesting confederations of financial services firms will emerge.  Kind of like a new hybrid of horizontally integrated banking Keiretsus.

Neew regulations will require the community banking institution to communicate with funding sources, equity holders and regulators that it truly knows its customer. The KYC will need to go deeper then determining an acceptable FICO score, federal ID verification and passing an OFAC screen. Employing risk management and opportunity discovery exercises with SME prospects and clients are principal business drivers and provide critical disclosure information to funding sources that address risk aversion concerns.

Funding sources and other stakeholders must be secure in the knowledge that the community banker understands the peculiar risk characteristics of the SME's strategy and business model. The community banker then becomes an effective risk manager whose vigilance and considered business judgment provides a fair return to funding sources, assures regulators that capital ratios remain strong and rewards shareholders with appreciating equity valuations.

Community banks are just one of the many choices an SMEhas to provide banking and financing services. Community banks must create a compelling brand identity and articulate their story with focused product marketing to selected SMB market segments.

 

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Risk: banking, SME