As you all know, I’ve been an ongoing supporter of the need for banks to step up to the plate and lend to Small Business. Credit availability to the small business sector is a necessary component to our nation’s economic recovery.
The History of the Small Business Credit Line
But I am also a banker, and as such, recognize the need for safety and soundness in lending. I blasted the industry over the last decade when they foolishly disregarded prudent lending practices, leaving the door open for business “liar loans”. During that time, a business owner could obtain a small business revolving credit line for up to $100,000 by completing a one page application. They didn’t have to provide any verification of personal income or business revenue. They didn’t have to substantiate a profit or the ability to repay the debt. The loan commitment was based almost entirely on the credit score of the individual owner/guarantor. In that era, if you had a pulse and a credit score of 700, you could go into any big bank and get a loan for up to $100,000. Well, okay, there was one other criteria: the loan amount was typically limited to 25% of the businesses STATED revenue. Everyone knew that if you STATED that you had $400,000 in business revenue, you could qualify for a $100,000 business credit line.
Additionally, the banking industry abandoned all forms of public filings on these credit applications. What does that mean? Well, first, because the loan was “to the business entity”, the line of credit did not appear on the individual owner/guarantor’s personal credit report. The bank also didn’t file a UCC filing on the business assets – the cheapest and easiest way to let other lenders know that one bank already has a loan out to a potential business borrower. So the line of credit became invisible to other potential lenders.
The result of these imprudent lending practices was that the business owner could go from bank to bank and accumulate credit lines. Banks had no way of knowing if that Small Business was applying for their first line of credit or their third, fourth or fifth line of credit.
These Small Business loans were rarely, if ever, sold through the securitization process. That meant that the entire credit risk was held on the books of the bank. When the economy began to crash and burn, so did the “liar loan” portfolios. Inside the industry, bankers scrambled to understand exactly how much exposure they had in this market.
Throwing the baby out with the bathwater: Banks withdraw from the Small Business Lending Market
In response to the economic crisis, the very first thing banks did was limit business revolving credit lines to Small Businesses to 15% of gross revenue. And thankfully, banks finally began to apply some level of credit underwriting to loan requests up to $100,000, requiring borrowers to submit tax returns to support the information they provided on the application.
At the same time, banks assumed that every loan they had on their books was a “liar loan”. So they systematically cancelled these credit lines to small businesses across our nation, stripping the businesses of working capital for salaries, inventory, rent and receivables. These businesses received no prior notice. The banks simply froze the credit line and sent the customer a letter, after the fact.
The banks did make one small concession to their small business borrower. They allowed them to apply to have their lines reinstated. These requests for reinstatement were subject to the “new” credit criteria. So in a year of often declining revenues, the banks applied their new guideline, limiting the borrowing to 15% of gross revenue. Many viable businesses no longer qualified under the stricter criteria and still found themselves without a line of credit.
At present, viable businesses have lost their access to working capital and banks simply don’t want to grant business working capital lines and retain the risk.
Did bankers learn their lesson? I think not!
You’d think that the banks would have learned a lesson on the importance of income verification from this. Unfortunately, they have not. The banks are promising a new round of lending to Small Business, and they will meet this obligation through Small Business Credit Cards.
Want a credit card with a line up to $50,000? Check out Bank of America or Chase Bank. Here’s how their process works:
- You will be asked to STATE your “household income”. Tell them whatever you want. They won’t even ask for a tax return.
- Business Revenue: Banks don’t ask and they don’t care. If they do ask, they won’t verify it. So feel free to lie.
- Credit reporting? Sure, the bank will pull your credit report to get your credit score. But then, just like the old days, the line will disappear from the radar screen. At Chase Bank, it appears that management encourages their business bankers to sell their Small Business Credit cards by advising the business owner of the benefits afforded to them when their new credit card is NOT reported on their personal credit report. The invisible business loan all over again. Shame on them!
- If you have a good credit score and a personal card from Bank of America, give them a call. Perhaps they will offer you the same deal they offered me. When I called customer service, The BofA representative offered to convert my personal credit card to a business credit card because I was such a valued customer! When I assured her that I didn’t own a business, she insisted that I didn’t need one to get a business credit card. Perhaps our regulators would like to monitor the prevalence of this practice throughout the industry and prohibit the banks from circumventing the spirit and intent of the Credit Card Act.
The Question is…. WHY are banks doing this? Greed! (Of course)
Why would banks continue to lend without regard to any of the time-honored traditions of safety and soundness. First, unlike Revolving Small Business Credit lines, banks DO sell-off credit card exposure through securitization. The bankers, together with Wall Street, devised a way to reap the profits while, at the same time, absolving themselves of any losses. Securitization rules, in their current form, empower and even encourage banks to violate all prudent lending practices.
A key lesson learned from the financial market disruption is the need for bankers to apply sound, consistent underwriting standards regardless of whether a loan is originated with the intent to hold or sell. The OCC reminds bankers that underwriting standards should not be compromised by competitive pressures or the assumption that the loan will be sold to third parties.
banks continue to apply lower credit standards to forms of credit they will sell off in the market than they do to credit they will retain on their books. Just compare the banks requirements for a $50,000 Business Credit Card to a $50,000 small business revolving line of credit. The first fails to verify ANY financial information and is sold. The second verifies financial information and the risk is held by the bank.
Business Credit Cards are a profitable and huge market for big-banks. Here are a few statistics from Creditcard.com:
- In 2008, JPMorgan Chase was the largest issuer of small business credit cards with $34.5 billion in total card volume. Bank of America is second with $26.31 billion and Capital One is third with $20.7 billion. (Source: Nilson Report)
- Credit cards are now the most common source of financing for America’s small-business owners. (Source: National Small Business Association survey, 2008)
- 44 percent of small-business owners identified credit cards as a source of financing that their company had used in the previous 12 months —- more than any other source of financing, including business earnings. In 1993, only 16 percent of small-businesses owners identified credit cards as a source of funding they had used in the preceding 12 months. (Source: National Small Business Association survey, 2008)
Congress Empowers Bankers to be greedy and deceptive to Small Business
Our Congressional leaders failed to include Small Business Credit Cards in the new protective laws provided under the Credit Card Act of 2009. Do our government leaders actually believe that it is okay for banks to practice deceptive and unfair lending against Small Businesses, but not consumers?
Many of the provisions of this Act do not go into effect until 2010 (giving the banks plenty of time to jack up everyone’s credit card rates to almost 30%). Buyer Beware! Small Business owners need to know that Small Business Credit cards are not protected from deceptive and unfair credit card banking practices, such as:
- Interest Rate Hikes – any time for any reason
- Universal Default
- How banks apply your payments - Lowest Interest Balances Paid First
- Limits on over-limit fees
I suspect, that absent a change in regulation, the following disclosure from Chase Bank’s new INK Small Business Credit Card will remain the same long after the provisions of the Credit Card Act go into effect. Perhaps the disclosure should be called “Chase Bank’s transparent disclosure of deceptive and unfair credit card practices, rather than:
- You authorize us to allocate your payments and credits in a way that is most favorable to or convenient for us. For example, you authorize us to apply your payments and credits to balances with lower APRs (such as promotional APRs) before balances with higher APRs.
- Claims and disputes are subject to arbitration.
- As described in the Business Card Agreement, we reserve the right to change the terms of your account (including the APRs) at any time, for any reason, in addition to APR increases that may occur for failure to comply with the terms of your account. (emphasis in original)
Our government leaders and our regulators failed to protect this country from unsafe and unsound lending practices, which brought our economy to the brink of collapse. As they develop their new-found focus on Small Business lending, they need to ensure that credit, in every form, adheres to the principles of safety and soundness and of honesty and integrity throughout our financial system. These principles must be adhered to by BOTH the borrowers and the banks. And sadly, perhaps neither can be trusted to simply “do the right thing”.
Yes, we certainly do need to make loans to the small business community. I feel their pain. But, America, as a world leader, needs to set an example and do it right and do it NOW. The securitization market isn’t going to magically improve because our tax dollars temporarily guarantee the risk to investors (TALF). And without a strong securitization market, credit in this country will remain frozen. Lending will only improve when we implement strict and meaningful regulations that govern the safety and soundness in our lending system for all forms of credit. The ultimate investors in these loans must feel secure in the likelihood that these loans will be repaid. It’s an issue of confidence. Banks and Wall Street have a long way to go in winning back the trust of the public. I don’t think they can get there on their own. I think we need to bring them there (and they’ll be kicking and screaming all the way).
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