Small Business Still Caught in Grip of Credit Crunch : Economy: Despite signs of recovery, money is tight because of strict new laws and tough bank examiners.

WASHINGTON —  Don’t tell Robert Sommers that the credit crunch is over. He’s been scorned by more than 40 banks and thrifts in his desperate search for a lender to finance a $2-million project to build homes on half-acre lots in San Diego.

Time was when bankers would ask the veteran builder to put up just $200,000, a mere 10% of the cost. Today, the loan officers shrug their shoulders, blaming tough federal rules when they insist that he contribute $800,000 as his share of the project. “And nobody has that kind of money,” lamented Sommers, president of Axiom Homes in Escondido.

Welcome to the new world of credit, where tough laws, aggressive federal bank examiners and nervous lending officers have made money scarce for the small-business person.

Despite indications of a reviving economy, the credit crunch shows little sign of letting up. Business loans continue to decline nationwide. The drop is even steeper in California, where real estate developers in particular have been virtually shut out of the credit markets.

The situation could get even tougher next year when banks and thrifts will be forced to make new public disclosures of the fair market values of their assets, including securities and real estate. This step will force banks and thrifts to set aside even more money for projected losses on bad loans, reducing their already-cramped ability to finance small and medium-size businesses.

Fearful that some banks are using “accounting camouflage” to disguise their real estate losses, House Banking Committee Chairman Henry Gonzalez (D-Tex.) is demanding that federal regulators be especially vigilant in carrying out this new provision of banking law.

“I do not want a repetition of the 1980s, where the true condition of the unhealthy parts of the savings and loan industry were hidden, partly due to poor regulatory practices and accounting practices that did not disclose market value,” Gonzalez warned bank and thrift regulators in a Nov. 19 letter.

Gonzalez could be headed for a confrontation with the new Administration, because top advisers to President-elect Bill Clinton are increasingly fearful that the scarcity of credit could hamper a full-fledged recovery. Robert Reich, a key figure in the Clinton transition team, suggested recently that the new Administration will press for an expansion of bank lending. Yet many doubt whether the pleas of a Democratic President will be any more successful than the exhortations of Republican George Bush in persuading federal bank examiners to take a more lenient approach when they review bank loan portfolios.

“The Clinton people have real limits on what they can do and act responsibly,” said Jeff Faux of the Economic Policy Institute, a liberal Washington research organization. “Given the history of the 1980s thrift failures, there is a real question about how much you can push the regulators to loosen up.”

This suggests a gloomy future for entrepreneurs such as Sommers, whose payroll has shrunk to one person--his secretary--instead of the 250 workers who would be scrambling to complete the houses he dreams of building. “There’s a tremendous fear out there; bankers just don’t want to take risks,” said the 35-year old builder.

He is not alone in the search for the elusive loan. “We now live in a risk-averse climate, an overhang from the savings and loan debacle,” said economist Faux. “Bankers are scared.”

With interest rates at extraordinarily low levels, bankers find it more profitable and a lot less worrisome to invest in government securities rather than the hopes and dreams of the owners of small businesses.

The historic core of banking--commercial and industrial lending--is shrinking. This category of loans totaled $546.1 billion at the end of June, a 7.2% decline from the previous year, according to the latest available data from the Federal Deposit Insurance Corp. At the same time, the banks held $228.6 billion in U.S Treasury securities, a hefty 32% increase in just a year.

It’s even worse in California for would-be borrowers. Commercial and industrial lending by banks in the state is shrinking more rapidly than the national figure, with loans dipping to $61.6 billion in June, a disturbing 13.9% decline. Meanwhile investments in Treasury securities soared 55% to reach $10.1 billion.

People who run small businesses “have to go through all sorts of hoops” before they can get loans, complained Terry Hill, a spokesman for the National Federation of Independent Business. “Before, they could just say, ‘I’ve got this house, or this piece of property for collateral,’ ” Hill said. “But the scrutiny of collateral is much closer these days; real estate has depreciated and they can’t get the same guarantee they could before.”

Businesses are scrambling for other ways to get money rather than pleading with the banks, Hill said. “It’s desperate,” with companies squeezing all the cash they can out of the business by slashing overhead and deferring expansion and equipment purchases, he said.

The credit crunch is a sad example of “the law of unintended consequences,” said Timothy J. Ryan, director of the Office of Thrift Supervision. Outraged by the depredations of men such as Charles Keating at the failed Lincoln Savings & Loan, which cost taxpayers billions through phony appraisals, false real estate deals and inflated profits, Congress cracked down hard.

With a series of laws starting in 1989, Congress set strict capital standards for banks and thrifts, and sharply curtailed the discretion of federal bank examiners. And the legislators put the examiners on the spot, sometimes literally, at witness tables in hearing rooms crowded with television cameras. Reports and evaluations and even notes from years ago were questioned, scrutinized and attacked by members of Congress.

The message examiners carried away was simple: Nobody gets in trouble for being too tough. But a hint of excess leniency can ruin a career.

“If you treat commercial banks, well-managed banks, as if they were dishonest or crazy savings and loan associations, they will not lend,” said G. Larry Engel, chairman of the American Bar Assn. task force on credit crunch causes. “Borrowers will not be able to get any money. How can a banker guess what an appraiser will do a year from now?” said Engel, an attorney with Brobeck, Phleger & Harrison in San Francisco.

He cites the hypothetical case of a good building, appraised at $12 million, filled with tenants, and with the owner making timely payments on his $10-million loan. But the real estate market is weak, and the annual appraisal now required comes in at $8 million. The bank examiner insists the loan is now a problem loan. Suddenly, the bank has to put aside $2 million, money taken out of profits, as a reserve to cover the potential $2-million loss on the loans.

The building is still making money, but the loan is bad because of tougher rules that grew out of the collapse of hundreds of insoLs. The next step for the banker is to try to sell the loan.

Bankers are “selling loans for regulatory reasons and not for financial reasons,” said Engel. The rules “seem to elevate theoretical accounting principles above our national priority for jobs and economic recovery.”

If the bank unloads the loan at a loss, just to get rid of it, the new owner who paid a bargain price can afford to cut the rents in the building. This enables him to lure tenants from other buildings, driving down their value and appraisal, deepening the crisis in the real estate market and jeopardizing loans at other banks in a continuing spiral.

Federal regulators “have been extremely aggressive in forcing write-downs” of potentially troubled loans, said James Chessen, chief economist of the American Bankers Assn. “We run the real danger that if we force additional arbitrary write-downs . . . we will completely shut off any lending on real estate,” he said. “At a time when banks are being asked to help push economic growth in a very weak economy, these kinds of measures are only going to set us further back than we are today.”

With the election of Clinton, “credit availability now is a Democratic issue which is going to require the Democrats in the House and Senate to work with Clinton to get something done,” said Chessen. The Bush Administration’s proposals to ease the regulations were ignored by the Democratic Congress.

There is no reason to believe that influential members of Congress such as Gonzalez, with fresh memories of the S & L debacle, will be cooperative with a Democrat asking forbearance toward the banks.

“It is essential that banks disclose the fair market value of their non-performing real estate loans and foreclosed real estate,” Gonzalez wrote to the regulators. “I do not want the regulators to use the excuse that this provision cannot be implemented because banks do not know how much their real estate is really worth.”

Despite the complaints of small business, the tough standards are likely to stay in place. “After all, we do not want to see a repeat of the troubles of the past,” Federal Reserve Board Gov. Susan M. Phillips told a recent meeting of the Assn. of Bank Holding Companies.

Don’t expect any relief, was the message delivered by Stephen Steinbrink, acting comptroller of the currency, to a banking conference sponsored by the American Institute of Certified Public Accountants.

“For the foreseeable future, banks will be operating under greater regulatory restrictions than at any time in recent memory,” Steinbrink said. “And, at the same time, they will be asked to provide more loans to fuel economic recovery--particularly for small business. The real question is whether banks will be able to meet all these demands.”

Some people already have decided that the answer is no, and they offer new solutions for the credit crunch. Many of San Diego’s most reputable builders were crippled by the recession, have exhausted all their assets, have no money to contribute as equity and thus cannot find any way to get bank funding, said Mary Lou Newbold, a veteran of 20 years in banking.

She has started a new company to get other sources of money for builders. She is finding investors who will become equity partners and share profits with the builders, and who are not subject to the capital rules and regulations governing banks.

Newbold expects to get two projects under way next year, one for 34 homes and the other for 17.