Blessings of Liberty

Speaking last June at the White House Conference on Small Business, President Clinton praised the "leaner, more invigorated, more committed" Small Business Administration (SBA). The loan-guarantee program of this small federal agency, he said, is the best way to get venture capital into the hands of America's entrepreneurs. Nine months later, the SBA followed up with a report identifying the most "small-business-friendly" banks in the country. Among the nation's very best: First Capitol, in York, Pennsylvania. But a close look at First Capitol doesn't reveal how the federal government builds what Clinton called tomorrow's Intel, Apple, and FedEx. Instead it shows how banks can boost small businesses better without government help.

First Capitol Bank builds small businesses on character, trust -- and a good feel for fruit

With three branches in central Pennsylvania, First Capitol has lent more than $50 million to local small businesses -- 15 percent of which are headed by women or minorities. Their loan default rate is a meager 1.5 percent. By contrast, the default rate on SBA loans in the area is 6.2 percent. Its default rate nationwide is even higher.

First Capitol's clients include high-tech startups, construction companies, retail franchises, and mom-and-pop grocers. Its loan officers write business plans for their clients and meet with the entrepreneurs monthly, if not weekly. All this made First Capitol the fastest-growing bank in the region, boosting assets 16-fold from $5 million to more than $90 million in just eight years.

Most remarkable, First Capitol refuses to get the SBA or any government agency to guarantee its loans. "Why should we?" asks Tom Capello, First Capitol's president. "We pick winners."

Since First Capitol was founded in 1988 with only a card table and a telephone in shared office space, it has specialized in loans to small businesses. Other banks had written off York as a Rust Belt city doomed to sputter as the local Caterpillar tractor factory laid off workers. So depressed were regional expectations that no new bank had opened in York in nearly 60 years. First Capitol's founders saw the changing labor market as an opportunity to make money investing in startups.

Character as Asset

Ever since Thom Anstadt was in grade school, he had worked in his family's downtown printing shop. Eventually he and his uncle took over the company. When desktop publishing transformed the industry in the late 1980s, Anstadt proposed that the firm seek a niche in high-quality color printing. His uncle balked at the change, so Anstadt quit the business to start Colorgraphics, Inc.

"Most banks are allergic to startups," Anstadt says. "We had nothing. No equipment. Just an idea." He drafted a proposal and visited countless banks. According to Anstadt's own proposal, Colorgraphics would lose money for at least one and a half years because of its high start-up costs. Most scoffed. It was a loan, some bankers said, that the SBA would never guarantee.

But First Capitol did. The now-profitable printing firm has 22 employees and $2 million in yearly revenues. It has not only met every loan payment, but it has borrowed three additional times to expand.

Anstadt's story is typical of First Capitol. York, according to a top city official, is having "a small-business renaissance because of that bank." How does First Capitol do it? By counting on character.

Unlike other banks, First Capitol doesn't get Washington to guarantee its loans. At other banks, if the small business fails, most of the lost money is reimbursed by the government. These banks make money just by making loans. First Capitol only makes money if the startups succeed. And First Capitol has found that the best way to predict a business's prospects is to evaluate the owner's honor. While his competitors talk about the "two C's" of lending (credit and collateral), Capello has added another: "character."

To this end, Tom Sauer, the bank's chief loan officer, personally reviews each application. He and his staff spend hours talking with applicants about their businesses. He even meets with their families to make sure they'll have the necessary emotional support.

Most important, Sauer was not trained as a banker. Before coming to First Capitol, he had managed a local munitions factory. Although Sauer modestly says that means he "won't bump into the machines" when he tours businesses, it also means he understands them. "The other [banks] I applied to just looked at my numbers," says a local grocer who got a loan from First Capitol. "That doesn't tell them much. [Sauer] would smell the fruit to make sure it was fresh. He walked the aisles. He knows what I'm about."

Ultimately, each loan applicant also meets with Capello. First Capitol has found that letting even the smallest applicants meet with the bank's president strengthens their commitment to meeting the payments.

It works. Since March 1994, more than three-fourths of the bank's loans have gone to small businesses. In that same period, the bank's stock has risen more than 60 percent. And, the trend is upward: Profits in the third quarter of 1996 were the best ever -- 48 percent better than 1995. First Capitol thrives, not in spite of their SBA-free policy, but because of it. The rigidity and bureaucracy of the SBA's textbook loans may invite failure. For entrepreneurs like Patricia Cumor, failures cost jobs.

A Nimble Response

Six years ago, Cumor's company, First Capitol Insulation, needed a credit line. (Many local businesses are named "First Capitol" because York was the home of the Continental Congress.) As prices for labor and raw materials soared, she couldn't bill homebuilders for projects until they were completed -- a lag of four months or so.

Cumor called several of the region's biggest banks. Although her stellar credit history and client list virtually ensured repayment, the SBA couldn't accommodate her unorthodox loan. The banks rejected her application. She made plans to close her business, laying off two dozen employees. Somehow she heard of First Capitol Bank, which -- unrestricted by SBA guidelines -- extended her the credit. Cumor's company now employs 40 people.

Similarly, First Capitol supplied the seed money for a family-owned stationery store. Although profitable, its business is seasonal. Capello allows the stationer to skip payments during the summer and pay more in the busier winter. The SBA would have closed the store down after a few missed installments. "What we do is good business," explains Capello.

The government's inflexibility is also reflected in the paperwork its loans require. If Cumor had secured an SBA loan, she would have spent days filling out more than 100 pages of forms. Once First Capitol approves a loan, the process takes minutes. In fact, one way that Capello keeps interest rates low (usually about 1 point over prime) is by cutting bureaucracy. He estimates that he would have to increase his loan staff by nearly 50 percent to handle all the government paperwork.

SBA loans also hamper small-business expansion. For most of his life, Bill Crone has collected rare coins. He bought a small, profitable coin shop from his father, but changing tastes and the popularity of baseball cards have eroded the industry. Collectible coins and coin-boards (a gambling device legal in most states for use by charities), on the other hand, were becoming more popular. So, Crone opened the First Capitol Mint to make gold and silver collectibles wholesale.

When Crone secured the rights to stamp famous coins like one honoring baseball hero Cal Ripken, the mint took off. Within weeks he had eight distributors. Weeks after that he had 15, then 22, including some in neighboring states. Every time he adds a distributor, Crone secures credit from First Capitol to buy the gold and silver.

Why not the SBA? It's too slow. Small businesses like Crone's can't compete if they have to rely on government. Under the SBA system, securing approval for each distributor might take up to two months. Crone says if it took that long, he'd lose the account. "If that were the case, I'd never have opened up," he adds. The loan-approval board of First Capitol, on the other hand, meets weekly, so applications are always approved within a few days. For one important account, Crone was even able to get approval within 72 hours. For First Capitol, prompt service is not just a nice touch, it's vital. Better service, Capello says, boosts profits by giving the bank a competitive edge.

Good for Minorities

Likewise, First Capitol proves skeptics wrong when they say the private sector will leave women and minorities behind. Businesses owned by members of these groups account for about 15 percent of the bank's loan portfolio -- 7 points higher than SBA-backed banks in the region. To Capello, it just makes good business sense. "These are the fastest growing areas of the market," he says. "We want to be in on them."

First Capitol's loans are also more likely to succeed. The bank's flexibility and emphasis on character rather than business experience pays off. In his free time, Capello sits on a local nonprofit lending organization that makes direct loans to minority-owned small businesses. Of the last 12 businesses that received loans, 11 have failed. At First Capitol, on the other hand, minority- and women-owned businesses fail at the same rate as those owned by white men. Even President Clinton has conceded that the SBA was holding small business back. Small businesses, he said, needed less paperwork and regulation to thrive. He's describing the private sector.