Tight Credit Squeezing Small Businesses

Sharon McLoone
washingtonpost.com Staff Writer
Monday, December 8, 2008 9:00 PM

Ryan Fochler, who owns a 20-employee pet care business called Dog Paws 'n Cat Claws in South Arlington, was alerted by a middle-of-the-night e-mail on his BlackBerry recently that two credit card firms had reduced his credit line from $56,000 to less than $1,000. When he tried to find other sources of funding, he was stymied by banks hesitant to lend to small businesses amid deteriorating economic conditions.

Credit is nearly impossibly tight, as Fochler was finding out.

Loan volumes under the Small Business Administration's main small-business loan program -- called the 7(a) program -- were down 30 percent in the year ended in October compared with the previous year.

And more than 75 percent of the nation's banks said they had tightened their standards for loans to small businesses over the past three months, according to a recent Federal Reserve Senior Loan Officer Opinion Survey.

Small businesses are "getting hit from both sides," said Sandy K. Baruah, acting administrator of the SBA, because even the companies that have long relationships with financial institutions and are in solid financial condition are no longer getting new loans approved and are having existing lines curtailed.

"The other side of the coin is the raising of credit standards, declining credit scores of individuals and small businesses getting hurt because of the slow economy," he said.

Two new initiatives are in the works, intended to offer small businesses some breathing room.

The first comes from the SBA, which has given banks offering SBA loans some leeway in setting interest rates, a rather technical adjustment that is expected to increase lending. The agency has also encouraged banks to give customers more time to make payments and is reaching out to more rural and smaller lenders to encourage more financial institutions to make SBA loans.

Also recently, as part of an effort to get credit flowing again, the Federal Reserve said that it was creating a $200 billion plan to increase consumer lending, including small-business loans partially guaranteed by the Small Business Administration. The lending is scheduled to begin in February.

That won't be soon enough for Fochler, who was was shocked when American Express and Capital One killed his lines of credit overnight.

"I was sick to my stomach," he said. "There was no heads up. Not one bank warned me." Fochler was only alerted to the change because he had subscribed to a credit monitoring service.

Rosa Alfonso, spokeswoman for American Express, said clients are notified by letter within 30 days of any decision to reduce a line of credit, and that the company may send an e-mail in advance of the letter disclosing the change.

"We are selectively reducing credit lines to reduce our risk and our cardmembers' liability," she said. "Line reductions are one way we manage risk prudently, and we continue to make these decisions on a case-by-case basis. No one factor causes our decision."

Fochler had recently leased a facility to expand into grooming and retail services, but the space has remained empty while he looked for another source of credit. He has found the search for a loan time-consuming and disruptive.

"I'm constantly missing work as I've spent the last three weeks at what seems like the inside of every bank in the D.C. metro region," he said.

Baruah said the strong economic climate a few years ago may have created an environment where credit was "too loose." To respond to that, he said, banks recently raised credit standards and became more stringent in their loan decisions.

"But having said that, I think we're in a situation now where credit standards are too tight," he said.

Lenders, too, have been feeling the effects of the economic crunch.

The delinquency rate for the SBA's 7(a) program increased 38 percent from about this time last year, to 3.04 percent. The delinquency rate for its 504 program, used for funding long-term fixed assets like land and buildings, jumped 32 percent, to 2.21 percent.

Because of the high delinquency rate and other reasons, Bob Hoffmann, senior commercial lender with EagleBank in Bethesda, said he doesn't expect banks to loosen their loan requirements anytime soon.

But small business advocates hope the Fed plan to encourage loans will help.

"There is cautious optimism that the new facility, which is long-overdue, will begin to thaw the small business lending markets, which have all but stopped working," said Rep. Nydia Velazquez (D-N.Y.), the chairwoman of the House Small Business Committee. "More needs to be done, but this is a move in the right direction."

The SBA does not directly offer any loans itself, but it does offer guidelines and set certain rules for financial institutions participating in its loan program. It guarantees 50 to 85 percent of a loan to a qualifying small business.

That partial guarantee had made packages of SBA loans attractive to buyers in the secondary market, in which loans are packaged and sold.

About 40 percent of SBA loans had been sold to investors. But returns have dropped -- when buyers can be found at all. That has made banks and other financial insitutions hesitant to offer SBA loans.

Declining credit scores among applicants is a common barrier. Ed Somerville, a 61-year-old Vietnam veteran whose firm helps small companies do business with the federal government, applied for an SBA loan with the help of business advisors at a nonprofit. He was rejected. He discovered four erroneous items totaling $500 on his credit report. It took him months to clean those up, but he was able to get his credit score to a respectable 682. He applied for a $25,000 Patriot Express loan designed just for veterans. Innovative Bank of Oakland, Calif., rejected him because it considered his line of work -- "consulting" -- too risky.

Innovative also is no longer lending to small businesses in the mortgage, limousine consulting and trucking industries and has limited funding for start-up businesses to five loans per month.

Hoffmann said most banks are looking for higher credit scores when it comes to small business loans these days. "In the past 625/630 was an acceptable score, but we're kind of moved up and are looking more at 650 while some lenders are cutting off at 700," he said.

Baruah said at this point loan seekers may be better off looking for loans from a smaller, community bank. "The larger the bank, in many cases, the more likely they are to make a decision exclusively on a credit score, while smaller banks may place a greater emphasis on a business plan or the track record of the company."

As for Fochler, he did manage to find a $10,000 loan, but not from a conventional bank. It came from a small business nonprofit in Adams Morgan, the Latino Economic Development Corp.

Rob Vickers, the LEDC lending director, reviewed Fochler's financials and felt that Fochler was unfairly penalized by having his credit lines cut so abruptly.

"Because of banks' own mistakes in over lending in the past to people with poor credit, banks are becoming overly conservative," said Vickers.

LEDC gave Fochler a loan through SBA's microloan program. That type of loan is not partially guaranteed by the SBA. Rather, the SBA loans LEDC a line of credit at about 3 percent and LEDC lends it to clients at a higher rate. LEDC must pay the money back to SBA -- if an LEDC client defaults on a microloan, it's LEDC that must absorb the cost.

"The reason we made the loan was character, although of course we closely look at credit and other things as well," said Vickers, who was impressed with Fochler's ability to increase sales yearly and his accuracy in reporting his taxes. "His knowledge of the industry and his passion and dedication made it clear to me that he has a strong shot at succeeding.

"He's the perfect client."