THE FLIGHT OF BANKS By Sari Lesk, Milwaukee Business Journal. Comments and summary by Creative Investment Research
NOTE: We spoke with this reporter on Nov 30, 2021, This article was published almost a year later, on Oct. 21, 2022. A related article* published in the New York Times on the same day, 10/21/22, seemed to reflect our comments and research.
Morgan Phelps faced a business conundrum in the summer of 2020.
Phelps is the founder of Colorful Connections, a Milwaukee firm
that helps businesses attract and retain diverse employees. She formed her
business model in 2017 while working in the communications industry. After
completing accelerator programs, such as through BizStarts and gener8tor,
Phelps took Colorful Connections live in fall 2019.
Although demand slowed at the start of the Covid-19 pandemic,
Colorful Connections faced a new problem after the murder of George Floyd by a
Minneapolis police officer.
That event energized calls for racial justice and equity across
the country. Phelps suddenly had a rush of clients, but the cash flow from that
work wouldn’t come until later – sometimes months later – when clients started
paying their bills.
She said she turned to banks for a loan or line of credit to get
through that period. Initially, she said a banker told her banks weren't
lending in general because of the pandemic. When those opportunities reopened,
Phelps said the response she encountered was that “by no means were they going
to lend to a small business like mine and someone like me. They needed more,”
given the young age of Colorful Connections.
“Even seeing what was in the pipeline, what was going on, even
given the market, the climate, everything, it wasn’t enough for numbers,”
Phelps said.
Phelps is one of several local entrepreneurs who told the
Milwaukee Business Journal they struggled to access funding to start or scale
their business. Many of those small business owners said they found themselves
rejected by traditional banks, unable to overcome the underwriting criteria
used to determine how loans are doled out.
As the industry consolidates, banks close branches and more
banks adopt automation, industry stakeholders are raising questions and
concerns about how entrepreneurs like Phelps will finance their businesses.
Those concerns are not limited to individual entrepreneurs. Whether small
business owners can access adequate capital has implications for the community
as a whole, rippling into the number of jobs firms can create and economic
development in neighborhoods throughout southeast Wisconsin.
Colorful Connections
was high-risk for a bank, Phelps said, and she had to find operating capital
elsewhere. The business received a ThriveOn loan from the Greater Milwaukee
Foundation, for instance. She also received a loan and a line of credit through
Legacy Redevelopment Corp., a community development financial institution
(CDFI), in Milwaukee that lends to underserved clients – particularly
minority-owned businesses.
Phelps said after a year of stability, PNC Bank offered Colorful
Connections a small line of credit. She attributed her newfound access to
capital – not all she sought, but something nonetheless – to a continued
relationship with the officer overseeing her business account.
“What I’ve learned from other companies … (is) what’s helping
them advance is having a good banker relationship,” Phelps said. “Someone who
will advocate for you or just counsel you.”
Evolution in the financial ecosystem could make opportunities
for such relationships harder to come by.
Larger banks are buying up smaller competitors, and banks across
the nation are shutting down offices as they say customers are opting for
digital services. Nationally, the number of full-service branches as of 2021
had decreased 17% since 2009, when branch banking peaked.
In Wisconsin the drop was larger — 23.5% — according to a
Milwaukee Business Journal analysis of federal data. On a percentage basis,
Wisconsin ranks seventh in the nation for branch closures between 2009 and
2021.
The analysis examined which neighborhoods in southeast Wisconsin
were without a bank branch as of last year. The figures show that nearly 80% of
people who live in high-minority census tracts are in a neighborhood with no
bank branches, compared with 40% of people living in predominantly white census
tracts.
The income level within a tract reduced but did not eliminate
the disparity. According to the data, about 80% of people living in
high-minority neighborhoods that are low- or moderate-income are in tracts with
zero branches. About 56% of people living in low- and moderate-income
neighborhoods where most people are white are in tracts without branches.
Meanwhile, new
online-only platforms are entering the small business lending marketplace, and
stakeholders are deeply invested in how financial regulators are implementing
rules that could reshape the lending landscape. How these events will affect
entrepreneurs and, more broadly, community development remains to be seen.
For Phelps, operating cash flow has improved over the past year,
but capital remains an obstacle to growing Colorful Connections. She has yet to
find herself in the position to complete a planned digital platform and bring
it online.
“If I had surplus cash, capital, then fine, I can invest in this
thing that will make us grow and scale as we need to,” Phelps said. “Until you
have that, you’re just dealing with the same challenges and trying to make it
through.”
Bankers’ take
The findings come during a time when banks have been expressing
a greater commitment to racial equity. After Floyd’s murder, several national
banks asserted they would do their part to address racial wealth gaps, pledging
to help minorities access capital for a variety of purposes, including small
business lending.
Chase Bank’s parent company, for instance, said it committed $30
billion by the end of 2025 to support Black, Hispanic and Latino communities.
Within that pledge was a plan to provide 15,000 loans to small businesses in
those communities and to mentor entrepreneurs.
(See: https://blacklivesmattercorporatepledges.com/ Also see: Corporate Donations to Black Lives Matter Total $67 Billion https://www.prlog.org/12874879-corporate-donations-to-black-lives-matter-total-67-billion.html )
Bankers defend their branch patterns, saying they reflect current
customer habits. Rose Oswald
Poels, the president and chief executive officer of the Wisconsin
Bankers Association, said lending volume remains strong and that customers are
still fulfilling their baking needs despite branch closures.
Oswald Poels said banking regulations impede lending to new
businesses, no matter who the owner is. She said most businesses without a few
years’ worth of a track record must obtain their initial financing elsewhere,
such as from a CDFI – as Phelps did.
“When you do
your credit underwriting analysis, you’re looking for a history,” Oswald Poels
said. “Any startup doesn’t typically have a history, unless perhaps the
individual has a pattern of starting new businesses and can demonstrate
experience and success that way.”
A review by the Federal Deposit Insurance Corp. of banks’ small
business lending practices found otherwise, though. According to the 2018
survey’s results, more than 70% of both small and large banks say they’re
willing to lend to startups. Some banks reported they use different
underwriting procedures for those young businesses.
Oswald Poels said she encourages the owners of businesses of all
ages to foster a lending relationship, such as by inviting a lender out to
their operation to show what it’s about. She added that anecdotal evidence from
association members indicates Wisconsin banks are diversifying their staffs,
which she believes in turn will help more people develop a banking
relationship.
Staff diversification has been among the ways banks pledged to
help close the racial wealth gap after Floyd’s murder. Other commitments have
involved diversified lending.
U.S. Bank, for
example, started a program called U.S. Bank Access Commitment. The
Minneapolis-based firm, which is the Milwaukee region’s deposit market share
leader, said its program would support business owners of color, as well as
communities of color.
(NOTE: Creative Investment Research has filed a comment objecting to a set of proposed banking mergers. US Bank is included in this set. See: https://drive.google.com/file/d/1jWBxbggqJrhh3pLqBvrCNLJqelxpuWX1/view?usp=sharing)
U.S. Bank earlier this year also established a community
benefits plan as the firm acquires MUFG Union Bank. The bank developed the $100
billion plan in coordination with the National Community Reinvestment Coalition
and the California Reinvestment Coalition. Among other tenets, the plan calls
on U.S. Bank to open five new California branches in low-, moderate- or
middle-income communities where most people are minorities.
BMO Harris Bank, the second-largest deposit holder in southeast
Wisconsin, was another bank that pledged to address racial equity. The bank’s
$5 billion commitment over five years is called BMO Empower and is billed as a
way to address barriers facing minority families, communities and businesses.
Part of the pledge included $300 million in lending for women-, Black- and
Latino-owned small businesses.
(Creative Investment issued a statement in favor of this merger; See: https://drive.google.com/file/d/1EbJMk0KFbjyez6nPfKUWKzHPClDP9hZ2/view?usp=sharing )
Anthony Hudson, the bank’s
regional president for retail banking in Wisconsin, was an architect of BMO
Empower. He said the bank determined how it would make investments based on
introspection and feedback from customers.
In tracking the results of the program, he said, BMO has found
success in lending to Black- and Brown-owned commercial companies and that it
has ground to cover in its mortgage lending to minorities.
Similar to U.S. Bank, he said BMO started a special purpose
credit program, which it piloted in Chicago and northwest Indiana. The program
expanded to Wisconsin last year. Hudson said that product has served hundreds
of minority-owned small businesses.
“We’ve had our fair share of wins without having to do anything
with the credit criteria or underwriting practices,” Hudson said. “What was
different is how we approach those businesses that I think oftentimes in the
past were overlooked.”
BMO has built new relationships in an untapped segment by
setting it as a priority, Hudson said. Overall, he said BMO made more than $4
billion in investments about two years after Empower began.
Not everyone is convinced of the potential for banks’ racial
equity pledges to move the needle. Economist William Michael
Cunningham, for instance, has been tracking the Black Lives Matter pledges
on the website for his Creative Investment Research business. He tallied a
total of $70 billion in corporate pledges as of the end of September, including
Chase Bank’s $30 billion pledge.
Cunningham said the banks’ pledges are disingenuous, because
“they don’t require that you do anything extraordinary.” They served as an
expedient solution and a recruitment tool, he said.
“They don’t require that you change these biases,” he said. “All
they require you to do is pledge some portion of your current business
activity.”
Cunningham said he sees some value in entities signaling their
interest in making a social impact. He also said he expects to see some
increase in lending to minorities, because the publicity around the pledges
will increase applications.
But if the
criteria used to determine credit risk don’t change, Cunningham said, the
long-term economic impact will be limited.
Seeking
transparency
Rachaad Howard says he
counts himself among entrepreneurs who haven’t accessed bank capital, including
through a program targeting Black-owned businesses. Howard owns Cream City
Print Lounge, an interactive screen-printing business he opened in 2019 after
about a decade working in the industry.
Previously, he said, he had a different screen-printing business
that sold to major retailers, such as The Bon-Ton Stores Inc. When the
department store chain went under, Howard said, he had to close the business
and start fresh. After taking a year off, Howard pitched Cream City Print
Lounge to a contest running in West Allis meant to attract new businesses.
Using his savings and winnings from the competition, he opened
the business and said he has shown a profit since.
Ready to grow
and expand, Howard said he began approaching banks that were publicizing
programs for Black entrepreneurs. He said he met the criteria listed on
programs’ promotional materials, but his requests for a line of credit were
rejected. The reasons, Howard said he was told, reached into his past, such as
student loan debt or a disputed medical bill.
Since then, Howard closed his storefront and is focusing on
mobile operations while he continues exploring opportunities to expand Cream
City Print Lounge. He said he’s interested in bringing on an investor or
crowdfunding rather than borrowing from a CDFI, because he is concerned about
the interest rate he’d face.
“We have everything that shows that we’re on an upward path,”
Howard said. “Getting denied, and then that affected my personal credit,
(which) is not OK. Our goal is to franchise eventually, but we have to get
these lines of credit and financing in place before we can even look at that.”
He said he hopes banks will be more transparent about what they
need to approve a loan or line of credit.
‘Without a bank’
Other entrepreneurs
say their experiences with banks have turned them off from further engagement.
Aureal Ojeda said she
was rejected by four banks after she started Outwoken Tea by bootstrapping the
business. The sustainability-focused merchant sells tea from farms around the
world.
Ojeda said she was surprised to find herself rejected given her
high credit score, a clean payment history and strong income from working in
construction. Bankers, she said, told her they couldn’t lend to her because she
lacked business credit history – which she was trying to establish with her
application.
Although he turned her down, too, Ojeda said a BMO Harris Bank representative referred her to the Wisconsin Women’s Business Initiative Corp., another CDFI.
Industry
experts say CDFIs such as Legacy and WWBIC serve a critical purpose for those
underserved by traditional finance. As smaller organizations, they can be a
more expensive source of capital, and their collective impact has its
constraints.
But they’re a resource for the would-be bank borrowers who say
they’ve been shut out from mainstream finance.
Through WWBIC, Ojeda obtained her first business loan, which
allowed her to buy inventory and a computer. With improved cash flow, she said
she has since acquired multiple business credit cards for Outwoken.
Ojeda said she is unlikely to seek bank financing for future
expansions.
“I’m not saying that banks aren’t good, I just feel there’s so
many other opportunities to grow your credit, grow your lines of credit, build
your business credit,” she said. “I’ve done them without a bank.”
Research shows
Little concrete data are available that illustrate banks’ small
business lending patterns. The Paycheck Protection Program offers some recent
insights. Lenders of all natures originated the fully guaranteed loans under
the Covid-19 stimulus program.
A February study from researchers at New York University and the
National Bureau of Economic Research examined all PPP loans made by Aug. 15,
2021. The authors found that despite the program’s explicit mandate to serve
disadvantaged businesses, many traditional banks’ PPP originations did not
demonstrate they had served Black-owned firms proportionately. Rather,
technology-based lenders served those borrowers and accounted for more than
half of the PPP loans made to Black-owned businesses.
The researchers said they found “suggestive evidence that
preference-based discrimination helps to explain lower rates of lending to
Black-owned businesses among smaller conventional lenders.”
(See our survey from 4/24/20: "Black American Business Owners Sound Off in New Survey of PPP Programs" - https://www.blackenterprise.com/black-american-business-owners-sound-off-in-new-survey-of-ppp-programs/ )
Another hint at
lending patterns comes from the SBA and its flagship 7(a) program. A prior Business
Journals analysis of SBA data found lending under the program overall decreased
54% by 2019 since peaking in 2007. During that same time, loans to Black-owned
businesses fell 84%.
In Wisconsin, the data show the number of SBA loans overall fell
57% in that timeframe, while loans to Black-owned businesses dropped 91% to 12
loans in 2019.
‘More than just
some numbers’
That was the type of lending Taj Pearsall was after
as he sought to open Wisconsin’s first location for chicken wing restaurant
Buffalo Boss. His cousin started the brand – which has attracted an investment
from rapper Jay-Z – in New York.
Pearsall planned to open a location inside the Sherman Phoenix
Marketplace, a development filled with small businesses in Milwaukee’s Sherman
Park neighborhood. Because he was joining the hub, Pearsall said he readily
accessed certain grants, using the guidance of the project’s developers. But he
still had a gap to close.
After facing
rejection from banks and investors, Pearsall said he turned to city government
to inquire about how to access other grants and SBA funding. He was referred to
Legacy, the same lender that helped Phelps.
While waiting for Legacy’s loan to come through, Pearsall said
he took out a high-interest loan to cover his continuing bills. His first
priority after he received the loan from Legacy was to pay down that debt.
He opened Buffalo Boss in March 2019.
“Once we got the funding, we couldn’t be stopped,” Pearsall
said.
He’s now working to open the state’s first stand-alone Buffalo
Boss restaurant, which will be on North 27th Street in Milwaukee. Rather than
revisit a bank for funding, he said, he stuck with Legacy to fund his
expansion. The CDFI had been a friend to Buffalo Boss, Pearsall said, and it
looked at him holistically when considering him as a credit risk.
“They gave me the money. I did exactly what I said I was going
to do with the money,” Pearsall said. “It worked, and everybody’s happy. The
bank looks good. The business looks good. We have a relationship. We prosper.”
Pearsall said he understands banks’ aversion to risk, but he felt their review of his application didn’t recognize his tenacity to accomplish his goals. He said he hopes banks will give people who don’t fit their model the “opportunity to be looked at as more than just some numbers.”
Closing time
The Business Journals’ analysis of branch data demonstrates the
distribution of remaining branches continues to reflect disparities in access.
Almost 90% of bank branches in the Milwaukee region are in census tracts where
minorities make up a low or moderate portion of the population.
Drilling down, the figures show about 78% of the region’s
branches are in low-minority census tracts, while 64% of the population lives
in such neighborhoods. On the opposite end of the spectrum, just 6% of branches
are in high-minority areas, while 16% of the region’s population lives in those
tracts.
About 80% of
the Milwaukee region’s bank branches are concentrated in middle- and upper-income
areas.
The analysis also found an uptick in the pace of branch closures
during the pandemic. From 2010 to 2020, an average of 14 branches in the
Milwaukee region closed each year. Last year, though, 22 branches in the area
shut down.
Across the country, the pace picked up from an average of 1,212
closures per year to almost 3,000 in 2021.
The FDIC’s study of small business lending practices found both
small and large institutions identify themselves as heavy users of relationship
lending, but small banks’ approach might be distinct from that of large banks.
“If that is the case, the decreasing number of small banks in
the country may disadvantage the small businesses that prefer a less
transactional approach,” the FDIC concluded.
The agency said in the report its interest in banks' practices
stemmed from how the decline in the number of smaller institutions overall and
the closure of branches by banks of all sizes could have an adverse impact on
small businesses.
The survey also found that large banks are more likely to rely
on standardization to make small business loans, creating an economies-of-scale
business model. Even still, banks of all sizes reported that relationships with
borrowers were a top reason to allow exceptions to loan policies.
Hard data, soft
data
Economist Mitchell
Petersen, a finance professor at Northwestern University who has
researched banking, relationship lending and access to capital for nearly 30
years, said his research highlights the value of a banking relationship for
borrowers.
His work has explored the roles of hard and soft information in
lending. Hard information, he says in his research, deals with factors that are
“easily reduced to numbers.” Soft information refers to those considerations
that are best understood within their original context.
Petersen said
his research demonstrates that the value of a relationship is mutual. A lender
might know valuable soft information about a borrower who doesn’t necessarily
look like a quality credit risk on paper, and that could improve a borrower’s
access to capital. Because of that relationship, he said, the entrepreneur is
more likely to stay current on payments out of a sense of obligation.
“Part of the ability to pay back is financial,” Petersen said.
“And part of it is effort. … Is this a person that when things don’t go well,
they will work 80 hours a week and do everything they can to save the business?
Or are they going to throw in the towel and give up?”
Beyond individual entrepreneurs, Petersen said, what’s at stake
in lending decisions and alternative efforts to raise capital is community
development.
"The strength and health of our communities is going to be
whether the right small businesses can raise capital,” he said.
‘A lot more
dreams coming about’
That’s a sentiment that resonates with Twisted Plants
co-owner Brandon
Hawthorne. With his wife Arielle, Hawthorne owns two southeast Wisconsin
locations for the vegan restaurant.
Hawthorne said he used credit cards and his 401(k) from a
previous job to begin with a food trailer. He sought financing to open a Cudahy
location for the restaurant but was unable to close a deal. One bank, he said,
inquired as to whether he had a life insurance policy he could put up as
collateral. He didn’t at that time.
Although
nervous after what he called an “off-putting” experience with banks, Hawthorne
said he approached WWBIC, where he received loan funding. That capital helped
Twisted Plants weather the pandemic, and he has now expanded the business to
Milwaukee’s east side.
Hawthorne said he understands that banks need to protect against
losses, but he felt the underwriting process he faced was too stringent. Unable
as a startup to produce a few years’ worth of financial history, “that
automatically cancels you out with the bigger institutions,” he said.
“I think if the financial institutions were less strict in
regards to what they required to acquire a loan, there would probably be a lot
more businesses and a lot more dreams coming about,” Hawthorne said.
Bank branch closures send signal to community
Observers and advocates find the disparities in bank branch
distribution extend beyond small business owners’ credit access.
Researcher Scott Hegerty, a professor at Northeastern Illinois University, said banks might not invest in a community by establishing a physical office. Given the expense of operating and staffing a brick-and-mortar facility, Hegerty said banks might instead contribute to organizations that work with the community.
An urban economist who grew up in Milwaukee, Hegerty has
researched banking deserts – including in the city. In a paper examining branch
patterns in Milwaukee and Buffalo, he found underbanked areas tended to be
“significantly poorer and less white” than other areas in the city.
Hegerty said he found income levels primarily were a driver of
branch distribution in Milwaukee. Bank deserts exist because people are afraid
to invest in a neighborhood, which Hegerty said creates a “signal.” Areas
lacking bank branches lack other types of businesses, such as grocery stores.
“The banks don’t want to come in. Nobody wants to come in. The
banks have abandoned us,” Hegerty said. “What that leads to is a disconnect
between people who are unbanked, and then they’re never part of the financial
system.”
Even with the pace of branch closures today, Hegerty said his
concern is not about how far people have to travel to the next-closest branch.
Instead, he worries about what is communicated when banks opt not to be present
in a community.
“It’s really not a physical problem. It’s not really an economic
problem,” he said. “It’s more a social and psychological problem.”
EVOLUTION OF BRANCH BANKING
The Milwaukee Business Journal’s
analysis of bank branch data examined banking industry consolidation since
branching peaked nationally in 2009. At that time, Wisconsin had 2,239
full-service bank branch locations, 714 of which were in the southeast region.
On a percentage basis, the number of branches that closed in the region between
2009 and 2021 outpaced the nation, the analysis shows.
For the purposes of this
analysis, southeast Wisconsin refers to the seven-county region that includes
Kenosha, Milwaukee, Ozaukee, Racine, Walworth, Washington and Waukesha counties
(M7).
2009
view of M7
In
southeast Wisconsin, data show branching peaked in 2009 at 714 full-service
bank offices as of June 30, up one branch from the prior year.
2021
view of M7
By
2021, southeast Wisconsin had 534 full-service bank branches, a net decrease
of 180 offices since 2009. The state’s branch count dropped in that same time
period from 2,239 to 1,714, a net decrease of 525 offices.
* Where $30 Billion to Fix Systemic Racism Actually Goes. New York Times (NYT). By Emily Flitter. Emily Flitter covers banking for The Times and is the author of “The White Wall: How Big Finance Bankrupts Black America.” The NYT article cited a law professor at the University of California, Irvine, saying “They’re willing and happy to do anything that goes into their regular business without sacrificing anything..”