Happy New Year Unlikely for Small Business

December 22nd, 2008

As small business owners brace for a tough 2009, we can only imagine what the picture will look like a year from now, and the forecast is not pretty. Banks have all but stopped lending, new credit card regulations to be implemented by July 2010 will not give immediate relief to small business owners currently dealing with higher interest rates and slashed credit limits, and the NASE (National Association for the Self-Employed) has warned about a new wave of foreclosures expected to impact small businesses in particular.

Last Thursday federal regulators issued new rules to curb many unfair and abusive practices by credit card companies; however, many are concerned about the next 18 months before the rules take effect. Seeking to reduce risk, credit card companies have been surprising and shocking small business owners by increasing interest rates and reducing or eliminating lines of credit, all at a time when businesses can’t find a loan and are trying to operate in a poor economy.

Credit cards are a critical source of financing for many small businesses. In fact, an NSBA survey this year reported 44% of all small business owners used a credit card to finance their business. In a CNN Money article by Kathleen Ryan O’Connor, Mike Haynie, a professor of entrepreneurship at Syracuse University, explained, “A lot of people use those cards for inventory, and it’s a revolving kind of relationship between buying inventory and supplies. When the credit card company takes away their ability to do that, it’s an instant hit on the bottom line. It’s particularly tough to swallow when it’s not because of a late payment or something like that but to reduce risk.”

The announcement of a federal crackdown on the credit card industry came as no surprise. Many have been calling for changes necessary to protect small businesses, which are the backbone of our nation’s economy and have generated 60-80 percent of new jobs in the last decade, according to the SBA. Here are some of the credit card rule changes to take effect in 2010:

1. Lenders will only be allowed to raise rates on new purchases or cards and will no longer be allowed to raise rates on existing balances.
2. Lenders will have to offer a longer period of time for a borrower to make a payment before it is considered late.
3. Lenders will no longer be allowed to charge high fees for exceeding a credit limit due to a hold put on a credit card.
4. Lenders will no longer be allowed to allocate payments to a balance with the lowest interest rate when a borrower has balances with different rates.
5. Lenders will not be allowed to make deceptive offers of credit
6. Lenders will have to give 45 days notice before making any changes to terms of an account.
7. Lenders will no longer be able to unfairly compute balances using a tactic known as double-cycle billing.
8. Lenders will no longer be allowed to add security deposits or charge fees for issuing credit or making it available.
9. Lenders will be required to apply any payment amount above the minimum to the part of the balance with the highest interest rate.

These changes were approved by the Federal Reserve, the Treasury’s Office of Thrift Supervision, and the National Credit Union Administration, and they are considered a step in the right direction in the effort to protect small businesses. However, the rules are being faulted for not taking effect soon enough, and for not doing enough to prevent large rate hikes. The changes will not be implemented until mid-2010, which means small business owners will have to keep on their toes in 2009 and continue to negotiate with lenders and shop around for the best credit card terms. When a credit card lender changes the terms of an account, you have the option to “opt out”, close the account, and take your business elsewhere.

Yes, 2009 is expected to be a tough one for small business owners struggling to find loans and negotiate with their credit card companies, and it doesn’t stop there. The NASE has warned about a new wave of foreclosures that could begin this last quarter of 2008, snowball through 2009, and have a direct impact on small business owners. According to NASE data released in conjunction with Prof. Samuel D Bornstein and CPA Jung I Song, small businesses own 93 percent of all “toxic” mortgages. By “toxic” mortgages they mean Alt-A, Alt-A ARMS, Option ARMS, and Interest-Only mortgages that were marketed to prime or near prime borrowers and are set to reset now through 2012. Based on the survey, approximately 3,709,800 micro-businesses hold “toxic” mortgages.

This means that many small business owners will soon be faced with much higher monthly house payments, and many don’t even know what they will be. And the majority of small businesses in our nation are run from a home office, according to the report, so a home foreclosure could result not only in the loss of a house, but a loss of an office or a whole business. The study presents some alarming statistics:

1. 22.9 % (3,709,800* At-Risk) of all self-employed business owners used risky or “toxic” mortgages or refinancing that are scheduled to “Reset”.
2. 19.2 % (3,110,400* At-Risk) of all self-employed business owners are at-risk of “payment shock”. They do not know the monthly mortgage payment that they will be required to pay at “Reset”.
3. 18.4 % (2,980,800* At-Risk) of all self-employed business owners are very worried about the monthly mortgage payment due at “Reset”.
4. 7.9 % (1,279,800* Immediate Risk of Default) of all self-employed business owners have already missed one to three or more monthly mortgage payments at this date before expected resets in 2009 to 2012.

Based on these facts, it seems small businesses are in for a tough 2009. Bornstein says, “The resulting defaults will be the cause of the upcoming second ‘tsunami’ wave of foreclosures that will dwarf the subprime crisis and will take many homeowners and small business owners.” If Bornstein is right, and new credit remains frozen while old lines of credit continue to be slashed and lenders continue to hike rates, this most certainly will not be a happy new year for small business, or for the economy as a whole.