Small-Business Lending: Who Doing It?

Fortune recently ran an article saying the big banks kept their hands off the lending button throughout the summer, taking in far more deposits than what they loaned out. Citigroup (NYSE:C) raked in $30 billion in deposits in the third quarter, while it lent just $4 billion. Since 2009, small-business lending at the country’s largest 18 banks declined 21%. Somebody has to be lending to small business.

What institutions might they be, and which ones could make good investments?

According to the Federal Deposit Insurance Corp.’s (FDIC) second-quarter data, small and midsize banks have a 54% market share in small-business lending yet control just 21% of bank assets.  Stacy Mitchell, a senior researcher at the Institute for Local Self-Reliance, believes the big banks need to be broken up to better match the scale of banks with the markets they serve.

In an Oct. 18 blog for Huffington Post, Mitchell writes: “Studies have found that regions where big banks are especially dominant end up with fewer small businesses and slower job growth over time than areas where small local banks are still vigorous.”

To find these more robustly growing areas, I’m inclined to look to those states and Census metropolitan statistical areas that have the lowest unemployment rates. According to the Bureau of Labor Statistics, the three states with the lowest jobless rate in September were North Dakota, Nebraska and South Dakota. Not surprisingly, the cities with the lowest unemployment rates were located in states with low joblessness.

Many of the banks operating in these states are community owned, locally operated lenders, with an intimate knowledge of their community. Public companies are rare, and so my search for investable small-business lenders will likely have to fan out across the country.

The Small Business Administration defines small-business loans as those under $1 million. In its December 2010 report on the state of small-business lending in the U.S., it ranks 82 banks with total assets of more than $10 billion based on their small-business loans as a percentage of total loans and as a percentage of total assets. Many of the leaders in this ranking are companies like American Express (NYSE:AXP) and Capital One Financial (NYSE:COF), which have significant credit card operations. I”ll focus on banks outside this group.

The first one is Wintrust Financial (NASDAQ:WTFC), an Illinois-based holding company with total assets of approximately $17 billion. It operates primarily in Illinois and Wisconsin. Wintrust began developing a network of community banks from scratch in 1991, and today its commercial loans account for $2.7 billion, or 23%, of its total loan portfolio and 16% of total assets. In the first nine months of 2012, commercial loans increased by $530 million, or 38% of its increase in average loans.

Wintrust specializes in premium financing for life insurance and commercial loans. These two areas alone represent an additional $3.6 billion in lending, much of it to small and midsize businesses. Its stock is up 35% this year as of Oct. 19. Over the past 10 years, it’s averaged an annual total return of 2.9% compared to -0.22% for its regional bank peers.

Most important, Wintrust has made money every year for the last 10, and it has increased its tangible common book value per share by 10% annually over this period. It’s a friend of small business.

Down in North Carolina, First Citizens Bancshares (NASDAQ:FCNCA) has a 3.7% market share in the state, the fourth-largest by deposits. Unfortunately, it’s up against big players like Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC), which combined have almost 17 times the deposits in North Carolina.

Nonetheless, First Citizens does just fine. In 2011, its net income was $195 million on $1.34 billion in revenue. In the second quarter of 2012, its net income grew 77%, primarily due to lower provisions for loan and lease losses on loans acquired in conjunction with the FDIC.

Between 2009 and 2011, FCNCA acquired $3.9 billion in loans and assumed $5.6 billion in deposits of six banks in California, Colorado and Southern Florida. These loans provide significant protection through loss share agreements with the FDIC.

In terms of small business, its commercial loans at the end of June totaled $7.8 billion, or 58% of its total loans and leases and 37% of its assets. However, a significant portion of those commercial loans are mortgages on properties. Its actual commercial and industrial loans are $1.7 billion, or 12.6% of its overall total. Still sizable, but not nearly as impressive as Wintrust’s commercial business.

My last example is PrivateBancorp (NASDAQ:PVTB), an Illinois-based holding company, whose peer group includes both Wintrust and First Citizens Bancshares. When the current management team took over in 2007, commercial and industrial loans represented just 19% of its lending portfolio. As of the end June, they were 48% of the total.

While its focus is middle market, its community banking model still delivers to a considerable number of small-business owners. Of the three banks mentioned, PrivateBancorp’s history of profits isn’t nearly as stable. In 2008, for example, it lost $93.5 million on $405 million in revenue due to substantial loan-loss provisions, only returning to profitability in 2011. Nonetheless, I like its focus on the commercial market.

Of the three, I’m most interested in Wintrust. Its premium financing business makes it stand out from the rest. If you’re not entirely sold on any of these, perhaps the PowerShares KBW Regional Bank Portfolio (NYSE:KBWR) would be more inviting. It has a reasonable 0.35% expense ratio and invests in 50 of America’s regional banks, many of which make small business a priority– including PrivateBancorp and Wintrust Financial.

As of this writing, Will Ashworth didn’t own any securities mentioned here.

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