Credit Card Squeeze Hits Small Businesses

We’ve written off and on since late last year that the continuing cutbacks in credit cards would hurt small businesses, which have been the biggest source of job creation in the US for quite a stretch.

The importance of credit cards as a source of funding to small companies has gone largely unnoticed in the wider world, yet is well know to experts on entrepreneurship. Indeed, Amar Bhide, in his landmark The Origin and Growth of New Businesses, pointed out that, contrary to popular mythology, venture capital played a trivial role in forming new businesses. Personal savings, loans or investments from friends and family, and credit card borrowings were the most important sources.

And before readers chide supposedly foolish owners for paying interest, consider: using credit cards includes the astute use of float, which can give companies six or seven weeks of free money. And in better days, card companies offered products targeted to small business owners with favorable rates, often from 9% to 14% (and also offered them even cheaper “life of the balance” deals, now a distant memory). With interest tax deducible, this was a viable source of funds, particularly for companies that faced short-term financing needs, such seasonal sales patterns.

As we noted, American Express, first to target small businesses, halted its credit line programs as of early 2009 (regular corporate ards for small businesses are still in effect). Advanta, which focused solely on this market, has found itself saddled with a heap of bad debt (default rates of 20%) and has stopped extending new credit as of early June.

This New York Times is largely anecdotal, but does provide some useful data on the importance of credit cards to small businesses. The story fails to note, however, that small business credit cards are personally guaranteed by the owners, and the size of the individual credit limits means that banks rely on very simple metrics to make credit decisions. Thus they have been cutting exposures based on factors, such as declines in local real estate markets, that may have nothing to do with the health of a particular business. From the New York Times:

A crackdown on credit limits by card companies is squeezing the nation’s 27 million small businesses, exacerbating the problems brought on by a stagnant economy…..the financial crisis has dealt them a one-two punch, as big banks cut the credit card lines that many entrepreneurs were forced to lean on when a once-abundant supply of loans dried up.

As of April, 59 percent of America’s small firms relied on credit cards to help finance their day-to-day operations, up from 44 percent at the end of last year, according to the National Small Business Association.

The number of small-business owners who depend on a credit card to buy items as varied as paper clips and heavy equipment has climbed steadily over the years, from just 16 percent in 1993. Today, that group makes up 11 percent of the revenue for Visa and MasterCard, from 3 percent in 1998, according to David Robertson, who publishes The Nilson Report on the credit card industry.

But credit card terms have worsened sharply with the recession: three-quarters of small business said they have seen a large cut in limits over the last six months. That would not be so bad if other forms of credit were easily accessible. But banks and credit card companies, which opened their coffers when the economy was flourishing, are now pulling back from nearly everything that hints of risk.

“I’m a business in a bad time that wants to expand,” said Mr. [Louis] Licata, who added that he had been unable to get loans at Cleveland’s banks since the recession set in. Recently, the limit on three of the credit cards he uses for his law firm was slashed by a total of $60,000, he said, dousing plans to enlarge his business.

….small businesses were not included in the credit card reform legislation signed into law last month by President Obama, which limits excessive fees and interest rate increases on existing balances starting next year. A bipartisan coalition of senators is seeking to extend the legislation to small business…

Bankers say that credit card companies have no choice but to reduce credit to small businesses. Credit card delinquency among small-business owners is more than 12 percent, roughly two percentage points higher than credit card charge-offs among consumers…

Where small businesses had traditionally relied on bank loans, personal savings or relatives to help pay for their operations, credit cards provided additional flexibility and ease. Low introductory offers and rewards programs were icing on the cake….

Now, small businesses “are really having to scramble because often they don’t have the kind of flexibility they had before,” said Todd McCracken, president of the National Small Business Association. Further, credit scores of small businesses have been hurt as banks cut credit limits, making it even harder to get other types of credit…

Mrs.[Jeannie] Macone, the owner of the business in Florida selling equestrian-themed trinkets and home décor to retail outlets, said she had to retool her business in part because the credit lines on her cards were suddenly slashed, even though she maintained she paid her bills on time. Traditionally, she has relied on her credit cards to purchase inventory, which she then paid off as her customers settled their accounts.

But last fall, Ms. Macone, who took out a credit card with Advanta, opened her bill to find the company had raised her interest rate above 30 percent. A short time later, Advanta reduced her spending limit from $30,000 to $5,000. “When you have a business, it’s like, ‘$5,000? Please, what good is that?’ ”…

Ms. Macone said she has had to lay off three part-time workers who used to assemble orders for shipment in her warehouse, and cut the hours of two other employees. “I’m the warehouse help now — my husband and I,” she said. “I’m back out there picking orders. I haven’t picked orders in 10 years.”

The Wall Street Journal today discusses in a more general fashion credit card cutbacks and customer unhappiness. What is interesting about the piece is the subtext that customers believed they had a right to keep the same terms as long as they held up their end of the deal. That of course is NOT what that teeny print in the card agreement says; it reserves the right to change the deal at any time. Nor does the story bother pointing out the obvious (except by inference), that this sort of clamoring (as opposed to objections to terms that are borderline predatory) is very likely to go nowhere.

From the Wall Street Journal:

When Fred Wilharm decided to ditch his credit cards, he reached for the chainsaw.

The real-estate investor from Franklin, Tenn., sliced, drilled and shredded his credit cards in his YouTube video “The Tennessee Credit Card Massacre.” Mr. Wilharm says he had just paid off $3,000 in credit-card debt after the card issuers jacked up his interest rates, and that making the video helped him deal with his anger.

His only regret about the video: “Explosives would have been nice.”….

That’s provoking a backlash. Mr. Wilharm is one of at least several dozen people who have posted an online video of a “plasectomy,” a term credited to Dave Ramsey, a radio talk-show host with Fox Business News. Some depict cards being chopped with scissors, shredded in blenders or chewed by lawnmowers. Others show cards set on fire, or doused with liquid nitrogen and then shattered with a hammer….

“We have work to do,” Ken Clayton, senior vice president of card policy for the American Bankers Association says. “We certainly hear the outcry from the public and policymakers that we need to get our house in order.”

I guarantee the first line of defense will be a PR campaign.

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  1. JEFF

    My personal story.

    I used my credit cards to start a biz 9 years ago. Floated almost $50K for 3 years doing 0% balance transfers for $75 a pop ended up costing me $225. By then the biz was rolling, so I paid everything off.

    Then 2 years later I started a different biz this time I floated almost $100K they upped the fee from $75 to $99, but it was still 0% for a year, so it cost me almost $300. Just paid off my credit cards in full a few months ago.

    Now the offers I get there is NO Maximum Fee (Like the $75 or $99 I paid) its a flat 4% and the lowest rate I've been offered is 1.99% and its only for 6 months instead of a year.

    I got lucky on my timing as both my businesses are debt free and profitable now. I just cannot imagine how I'd make it today if I tried the same thing.

    Anyways, great blog and keep up the good work!

  2. Brick

    Credit cards filled the space when banks stopped doing proper diligence on small business loans. That small business should receive the same sort of protection from predatory credit card activity makes sense, but banks ought to play there own part in doing proper banking not just making a quick profit.
    Banks across many areas of the world still do this and in competition with securitised miss priced loans from the US in the past have come up with some very innovative products which benefit the consumer (like variable rate loans than can be converted to fixed at a moments notice). US banks and credit card providers need to change their business model or outside competition will wipe the floor with them.

  3. Richard Kline

    Banks ration small-scale credit, to businesses and individuals, not based on the the health of the borrower but based on the health of the bank. Period. As Brick mentions, doing due diligence on small loans is just not seen as cost-effective given the scale of the profit involved. In good times, lend to everybody, and you'll still be healthy. In bad times, cut 'em off, who cares.

    Americans believe, it's touching to watch this really, that they have a God-given right to financing. Because all those institutional safeguards and government backstops, and smallholder lending things established in the Thirties and Forties did, in fact, make basic credit very widely available to the middle class, and even parts of the lower class. Y'know: that government that certain dufuses want to get off our backs. But those same believers in a divine right to credit never asked _how_. So when the money stops, when the student grants became student loans became 'accepted but not funded,' it's "How did that happen?" When the card company jerks your rate to 29.99%, they ask "How did that happen?" Then the banksters borrow at 0% real and the public borrows at 15.99% and rising, they ask . . . well you get the picture. And here's the answer: "Because you let it happen while you were off throwing a party paid for by plastic."

  4. skippy

    May I add R.K…that some find indirect and direct mortar and small arms fire annoying when studying via the serve and learn program in the Armed Forces. What a great place, what a great place to be, hint standing between the TV and viewers in the military can result in injury by flying objects. Which can culminate in an article 15 non judicial punishment, under the providence of damage to US government property if unable to perform duty's.

    skippy…freedom to die, starve, be eaten, you get the idea…lets go camping in the triple canopy or bad ass desert…lots of freedom there.

  5. Anonymous Jones

    Here, here, Richard. I am continually amazed at the divine-right-to-credit idea that has taken hold. I've talked to many who continually use the word "should" when discussing credit. As in, "I should be able to get a home loan with no down payment. How else could I get a chance to buy a home?" Also, "I should have access to a credit card that never changes its terms no matter how much the world changes. How else can I plan for my future?"

    There's just a fundamental misunderstanding here. I always ask these people, "Why do you think the lender should cap its return when the lender is often taking just as much risk as an equity capital provider (write downs of up to 100%) and the equity capital provider (homeowner, business owner) has no such cap?"

    Riddle me that.

  6. donna

    Well, you often can't get a small business loan unless you've been in business a couple years, so how else are you supposed to get the capital to start a business?

    Using the float makes a lot of sense, and yes, it's a real drain on small businesses now not to have a reliable credit source.

  7. VG Chicago

    I will (once again) take the unorthodox posture here, and state that if a small business needs to rely on credit cards to stay afloat, perhaps the owners should consider getting a job elsewhere, or applying for an employment visa to China.

    Call me old-fashioned if you wish, but as a former small business owner, I cannot conceive relying on credit cards to get me through the day.

    Vinny G.

  8. bb

    those lines of credit can be indeed very useful, but if the default rate is 20%, interest rates below this mark are suicidal for banks.

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