While most of the nation’s attention is focused on saving behemoth financial firms, small businesses are struggling to ride out a perfect storm of tougher credit conditions in a badly hobbled economy.
The result is that the finance sector’s woes—which has spawned new lending prudence—is exacerbating, rather than relieving, economic weakness.
Even government programs designed to help small business are falling down on their mandate just when they are needed most, says small business advocates.
“It’s always been difficult for small business but now it is become almost impossible” to survive, say Marilyn Landis, chairwoman of the National Small Business Association (NSBA). “Many factors are coming together to make this a perfect storm for small businesses.”
Until recently most small business owners could go to their local banks and get unsecured loan of $100,000 or more but those days are long gone.
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In the past, owners could put up buildings or equipment for loans needing collateral; similarly service companies could post solid track records of positive cash flow.
But under sharply tightened lending standards these are no longer any guarantee to get needed funding.
Besides, with so much manufacturing having migrated offshore there is less equipment to use as collateral, and property values have plummeted around the country.
As a consequence, small businesses are now using bank loans—far preferable than relying on credit cards—is at a 15 year low.
Sixty percent of domestic banks reported having tightened standards on commercial and industrial (C&I) loans to medium and large firms, according to the Federal Reserve Bank’s July survey of senior loan officer’s opinion on their lending practices.
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But for small firms, terms tightened even more. Lending standards to small firms were raised on C&I loans at 65 percent of banks, up from 50 percent in April.
Some 32 percent of small business survey by the NSBA said they were experiencing worsening bank terms, forcing many to use credit cards more.
That’s more convenient for banks—which can shift debt off their books to a handful of credit companies – but it subjects borrowers to higher rates and terms that can be changed at will.
In an August survey, 67 percent of small business owners reported worsening credit card terms—up from 57 percent in February.
All this has added to small business owners being “extremely anxious” about the prospect for recession, according to a recent NSBA survey, which found 79 percent anticipating a recession or flat growth at best.
“Even the perception of such limitations on small business sector translates into prolonging the recovery of the US economy,” says the survey.
This is critical because small businesses are responsible for 93.5 percent of net new jobs created in the US since 1989, according to the NSBA.
The trade association’s survey says near-term prospects for new net job is stagnant.
“It’s a tighter market, it means it takes a little longer, there is a more scrutiny, consumers have to jump through a few more hoops to get that loan,” says Tracey Mills, a spokesperson for Consumer Banking Association. "And it’s a good thing because banks just want to make sure that whoever gets the loan, will have the ability to repay."
Co-mingled credit histories
One of those new tighter hoops is tighter scrutiny of credit scores.
But that particularly complicates small businesses because many owners’ personal and business credit histories are co-mingled, with the debt businesses normally have to carry pulling down overall scores.
Landis knows about this from personal experience. Her Pittsburgh-based company, Basic Business Concepts, Inc., which offers CFO services for small business, was recently turned down for a loan, even though she had never missed a payment.
In recent years she has grown from a single office to four – one in Cleveland, another in central Pennsylvania and another in New Hampshire – but now has to put expansion plans on hold.
That fits with the experience of Michael Mitternight, the owner of Factory Service Agency, a large air-conditioning contracting firm in a New Orleans suburb, established by his father-in-law in 1975.
Despite an unblemished record he is finding that banks are now demanding personal guarantees before they extend a line of credit, sometimes even for particular jobs.
Because of a general credit tightening everyone wants to get paid back sooner, much faster than the customary 45-60 day payback period, even while banks are taking longer to process loans.
That leaves his firm carrying extra costs—say, for equipment—for far longer, which cuts into this profitability, degrading his credit score, which in turn affects how banks regard his credit-worthiness.
“We are going to be reimbursed [eventually] but in the meantime we are going to have to borrow whatever money it takes and pay the interest on that and it’s hard to built that into the cost of a job—so that’s one way the credit crunch has tightened things for contractors,” says Mitternight. “This reduces your ability to grow, it cuts into your profitability—beside the fact that contracts are scarcer and harder to find because people are hesitant to invest in property.”
“Main Street and Wall Street are inextricably connected,” said Bruce Josten US Chamber of Commerce executive vice president, urging Congress in a letter Wednesday to act quickly on a bailout out package to stem further market damage. Failure to act, he warned, would make the harm already will in retrospect seem “only the tip of the iceberg because a lockup in credit markets will cripple Main Street’s ability to operate and threaten taxpayer jobs and income.”
Washington’s Small Business Administration can issue loan guarantees to banks to help them feel more comfortable making loans but Landis says this critical agency has been badly undermined by some of the most severe budget cuts suffered by any government unit during the Bush Administration.
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The terms have also become more onerous for banks, spurring some 400 to drop out of SBA supported programs since the first of the year, she said.
“It ought to be a counter-cyclical program—when the economy is challenged when small business is challenged you see SBA loan volume increasing but it decreasing dramatically in some states by 20 percent or more,” said Landis, who was a banker herself for 30 years.
“The program is just not working at this point and I don’t see anything in the bailout plan that will address that issue—I don’t see relief for small business.”