The Credit Crunch and Small Business

How directly will small business lending be affected by the ongoing financial crisis and forthcoming bailout? The evidence is mixed. Treasury Secretary Henry Paulson told Congress that the $700 billion plan was needed "in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy." Business owners with bad credit, unproven ventures, or companies tied to troubled industries such as housing have had a particularly hard time borrowing, but many banks still want to lend to established firms with good credit and collateral.

There's no question some companies are having credit cut off. In Ohio, banks are refusing to renew lines of credit and calling in loans made to decades-old family businesses that are current on payments, according to Dayton bankruptcy and workout attorney John Rieser. He says it's the worst borrowing environment he has seen in 20 years. The pullback began early in 2008 and accelerated in the last four or five months. "They're pulling the triggers and saying you're done," Rieser says. "It's not just sick businesses. These are healthy businesses, and that's the surprising thing."

Amid the widespread crisis, even healthy small businesses are feeling the squeeze. But some banks see an opportunity to lend

One of Rieser's clients, Tom Rajkovich, says he had a $340,000 balance on his commercial mortgage and $260,000 drawn on a line of credit from Chase (JPM) when the bank demanded repayment in the summer of 2007, saying he had failed to send financial reports required by his loan agreement. Rajkovich's six-employee company, Comet Automation Systems in Dayton, manufactures and imports plastics machinery and is heavily tied to the auto industry. While Comet, founded in 1974, has not turned a profit since 2005, Rajkovich had sales of $1.6 million in 2007 and says he is current on all his payments. He is now embroiled in a court battle with Chase, which declined to comment on the case. Rajkovich was turned down when he tried to get another bank to take over the loans, and he's trying a credit union now. "This whole thing just keeps putting bigger and bigger financial burdens on me," he says.

Lending standards for small businesses have been tightening at many banks for more than a year, according to the Federal Reserve's latest available quarterly survey of senior loan officers. In the three months ending in July, 65% of banks said they tightened credit for companies with less than $50 million in revenue. Lenders say they see companies tied to the housing industry—everyone from mortgage brokers to furniture makers—as particularly risky. And entrepreneurs who relied on home equity lines to fund their businesses have seen those sources dry up as home values fall.

Tougher Screening

The lockdown has been clear at Business Credit Services, an eight-year-old Las Vegas firm that helps business owners obtain credit. David Gass, the company's president, says he used to have little trouble getting $50,000 credit lines for new business owners with 640 FICO scores. Now banks want to see scores of 720 and companies at least two or three years old, and Gass says the options for borrowers have narrowed severely in the last six months. "We used to have 50 or 60 banks we could send people to with the basic $50,000 or $100,000 credit line. Now there are maybe five or six."

But stepping back, the picture is more complicated. The Federal Reserve reports that outstanding commercial and industrial loans totaled $1.51 trillion the week ending Sept. 10, up 12% from $1.35 trillion a year earlier. While there's no way to tell how much of that lending is to small businesses, it suggests that business borrowing on the whole is increasing. A Gallup poll of 610 small business owners in July conducted for Wells Fargo (WFC) found that only 14% had difficulty getting credit, while 41% said it was easy, although a membership survey in August by the National Small Business Association found that two-thirds of business owners had been affected by the credit crunch.

By John Tozzi