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Use TARP to Directly Aid Small Business Lending

Washington Watch

The NCE Spotlight

Use TARP to Directly Aid Small Business Lending

When the history of the worst recession since the Great Depression is written, August 2008 will stand out as a pivotal month. That appears to be when the credit crunch became a vicious cycle, consuming small businesses in a vortex of vanishing credit lines and increasingly restrictive loan terms.

For Mark Lane, president of Coed Sportswear and Printed Matter, that's when his bank of seven years called in all of their notes, despite the fact that he'd made a host of difficult decisions -- laying off employees, cutting benefits, and slashing other costs -- to maintain what he thought was a "strong, healthy" banking relationship.

"In 19 years of business, neither Coed nor Printed Matter has ever missed a payment on any of its term loans, mortgages, or interest payments," he told the Senate small business committee during a recent hearing. Even so, his bank froze all of his company's credit lines and asked him to find a new bank to take over all of its existing loans.

"I have made presentations to six banks since August, all with the same result. No bank is interested in taking on Coed or Printed Matter in the current economic environment without at least six months of sustained profitability," he says. Like most apparel companies, his firm's sales are seasonal. As such, meeting that standard, even in a good economy, would be difficult.

Because he now lacks credit, two otherwise healthy companies have become cash strapped, "making it difficult to pay vendors in a timely manner, making it difficult to make investments in our growth opportunities, and soon will impact our ability to fulfill future orders," he says.

Among small businesses, Lane's story is all too familiar. The National Small Business Association (NSBA) found in its year-end survey of members that nearly one third (28 percent) had credit lines or credit card limits cut in the previous six months. "These sometimes arbitrary reductions are having a profoundly negative effect on America's small business community," NSBA President Todd McCracken told the committee, who says the number is likely higher now.

Of course, the government's Troubled Asset Relief Program (TARP) was supposed to inject capital into banks to allow them to lend more freely. But as I noted last January in my column TARP Funds Fail to Reach Small Businesses, very little of that money has trickled down.

In fact, 10 of the 13 biggest beneficiaries of TARP reduced lending between the third and fourth quarters of 2008. During that time, their outstanding loan balances declined by $46 billion, or 1.4 percent, according to an analysis by The Wall Street Journal. In all, these banks received $148 billion in taxpayer funds intended to make loans more readily available.

Instead, many of those banks have made questionable use of the money. For example, Citigroup, which received $50 billion in TARP funds, made an $8 billion loan to a company in Dubai. And last November, Bank of America, the recipient of $25 billion in TARP funds, spent $7 billion investing in the China Construction Bank.

Those investments may well be prudent, but they fall outside the scope for which TARP funds are intended. Both banks, incidentally, would be bankrupt without government assistance.

Meanwhile, Bob Cockerham and his wife Mary are being pushed to be brink of bankruptcy. They own and have successfully run auto dealership Car World in New Mexico for the past six years. But their longstanding lenders have curtailed critical lines of credit and the auto dealership's floor plan financing, which is used to build and maintain inventory.

"In January 2009 we thought we had made all the hard choices and downsized enough to survive. However, we were told by our floor plan financing lender that they were convinced 2009 would be a much more difficult year, and we were not big enough nor did we have the financial depth necessary to withstand an even larger downturn," he said.

As a result, their lender decided to cancel an emergency $200,000 credit line established several years earlier, cut back on the amount of inventory that it was willing to finance, and gave them 60 to 90 days to find another lender. The dealership's credit record, he noted, was spotless. "We never missed a payment, never," he said.

"Since our lender told us they no longer want us as a customer, there has not been a day or a sleepless night that goes by that we have not been scared, angry, bitter, or upset. Mary and I feel as though we are fighting for our lives, and we are uncertain every day if we are going to lose everything that we worked our whole lives to build, both in business and personally," he added.

James Chessen, chief economist for the American Bankers Association (ABA), noted that banks themselves are under pressure from government regulators to tighten loan standards and are finding it more difficult to raise capital to sustain lending. Even so, he noted, business loans have expanded by 12 percent and consumer loans by 9 percent during the current recession; in contrast, the median number of business loans declined during each of the previous six recessions.

President Obama has already taken several steps to make loans more accessible by lowering or eliminating fees and by increasing government loan guarantees on Small Business Administration loans. But many small business advocates and lawmakers question whether this is enough in the current environment.

That has led to a movement in Congress to use TARP funds to aid businesses directly. Since the Senate hearing last month, committee Chairwoman Mary Landrieu, D-La., and Ranking Republican member Olympia Snowe, R-Maine, have asked Treasury Secretary Timothy Geithner to study the use of TARP to guarantee existing lines of credit for "qualified" small businesses.

Given the history of TARP, directly aiding small businesses would seem to be a far more productive use of the money. The government needs to break the vicious cycle where contracting credit leads to business cutbacks, layoffs, and declining sales, which trigger even more restrictive loan terms or the loss of credit all together. No economy can long survive that downward spiral.

Credit Woes Hit Home

A credit-card crunch is squelching the dreams of entrepreneurs.

Jack Diamond of Tampa, Fla., laid off employees after Bank of America cut his credit line. For two years, Jack Diamond used his Bank of America small-business credit card to finance his plants-and-aquatics nursery business in Tampa. He would use the credit card to purchase plants, then pay down his balance after he sold lilies, pond plants and aquatic fertilizer to customers.

Last September, Bank of America Corp. cut the $46,000 credit line on his card to $27,200, just a few hundred dollars above his current balance. He couldn't buy the plants, seeds and equipment he needed for his spring selling season. He laid off six of his eight employees.

"I'm almost living paycheck to paycheck," says Diamond, 55 years old, who is considering filing for business bankruptcy.

Even as wobbly banks tighten up on consumer credit cards, they are also cracking down on small-business owners by slashing their credit lines, closing accounts and raising interest rates. A recent Federal Reserve survey found that about two-thirds of banks' loan officers reported that they tightened terms for business loans in recent months. Meanwhile the National Small Business Association, a trade group, said 69 percnet of 250 surveyed small-business members faced worse terms on their cards, such as higher interest rates, in the second half of last year.

Banks have reason to get tough. In a bad economy, small businesses are usually among the first victims. Credit-card issuers have seen a surge in charge-offs, or debts no longer expected to be paid, over the past year as small businesses fail.

But the credit-card squeeze couldn't come at a worse moment for the estimated 27.2 million small-business owners who have long been one of the growth engines of the economy. Many, especially start-ups, don't have the track record or size to qualify for traditional bank loans. Even many established small-business owners use credit cards to pay salaries or buy inventory.

"People are using their credit cards to keep the businesses going, so when that dries up, the businesses go," says Jeanne Marie Cella, an attorney in Media, Pa., who has seen a significant increase in small-business owners filing for bankruptcy.

Indeed, the crackdown on business credit cards is happening just as the federal government scrambles to free up credit for small businesses by raising federal loan guarantees and reducing fees on certain Small Business Administration loans. In an attempt to get credit flowing again, the Treasury said it would buy up securities backed by SBA loans. Meanwhile, politicians in Congress are asking the Treasury to use more bailout funds to guarantee bank lines of credit for small businesses.

Until recently, credit-card issuers avidly courted small-business owners. Visa Inc., American Express Co., MasterCard Inc. and Discover Financial Services had an estimated 29 million business credit cards in circulation in 2008, up from just five million in 2000, according to the Nilson Report. Spending on the cards rose to $296.3 billion from about $70.4 billion over the same period.

Banks began moving into small-business credit cards in the mid- to late-1990s following the creation of credit-scoring models. One factor was a 1995 study by Fair Isaac Corp. and Robert Morris Associates, a trade group for loan officers and credit-risk managers, analyzing the performance of business loans.

The study surprised bankers. It found that a small business's cash flow and financial statements bore little correlation with how the owner would pay his or her bills. A much stronger predictor was the business owner's personal credit score. The banks concluded they could safely issue business credit cards to proprietors with good credit records even if the underlying business didn't appear to justify a loan.

"The credit-card industry noticed that study and that's when they started marketing business credit cards," says Robert Lahm, a professor of entrepreneurship at Western Carolina University. "Credit cards have become probably the most common small-business loan product."

Peggy Durant of Clearfield, Pa., took advantage of various personal and business cards' promotional offers to finance her and her husband's small businesses over the past decade, which include a bed and breakfast, residential and commercial rental projects and a solo law practice.

After J.P. Morgan Chase & Co.'s Chase Card Services in January raised the minimum payments on one of her cards, Ms. Durant decided to take out a first mortgage on one of her rental properties and open a business line of credit with her local bank to help pay off other credit-card balances and reserve a cash cushion in case more banks followed suit.

"It has created a sense of anxiety and made us do things differently than we would have," says Ms. Durant, 60. "That money is no longer there to use."

Credit-card issuers, naturally, see a different picture. The rate of business bankruptcy filings has outpaced consumer bankruptcy filings over the past 12 to 15 months. Average charge-offs for businesses with at least one charge-off jumped to nearly $11,000 from a little above $7,000 over the same period, according to data from Equifax Inc.'s commercial-business group.

Faced with rising losses, financial-services firms last year began scaling back credit lines, products and marketing to small businesses. In January, American Express discontinued its business line of credit and capital line program. Capital One Financial Corp. stopped offering small-business closed-end loans last year. Citigroup Inc. discontinued one of its business credit cards, the Citi Business Premier Pass card, late last year. Advanta Corp., which mainly offers small-business credit cards, raised rates on many last year.

Financial-services firms say they are trying to control their risk in the current environment. "The line reductions that might be made reflect concern about overall debt load relative to one's financial position in this environment," said Tom Sclafani, a spokesman for American Express. He declined to comment on individual customers.

Steve Brumer of Suwanee, Ga., says he has been squeezing his own customers since American Express cut the credit line on his business credit card to $20,000 from $65,000 and pared another line of credit that it later closed. In the past, Mr. Brumer, who sells wireless equipment to businesses, would typically give customers up to 30 days to pay their bills, since he would be able to rely on the cards' credit lines to fund his working capital in the meantime. Now, "I don't issue any lines of credit to any customers. It is all cash or all wire funds transfers for everything," says the 53-year-old.

Some small-business owners find their business-card problems spilling into their personal lives. Because the business owners usually agree to be guarantors for the cards, any delinquencies or other adverse actions are usually reported to their personal credit files, making it harder to get personal loans.

Kristie Jakeman of Jensen Beach, Fla., saw her credit score fall to 680 from 740 in January after Advanta started reporting her business credit card to credit bureaus as delinquent.

Her troubles began last summer after Advanta moved to raise her 7.99% interest rate to 9.9% in September, then to 21.9 percent in October. She complained to the company and says it promised to lower her rate but didn't. She continues to fight to have the charges reversed.

The higher payments made it harder to keep up, and she says she finally decided not to make her December payments until the company agreed to work with her. Advanta raised her rate to 33%. A spokesman for Advanta declined to comment.

Because of the drop in her credit score, Jakeman, 42, who runs a racehorse-management business and a company that develops nutritional supplements for animals, says she was turned down for a small-business loan. She is now looking for a business line of credit, which has a much lower credit limit. "We're back to a $50,000 line of credit, which severely limits our growth. I'm certainly not going to go out and hire people.