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This story appears in the February 2009 issue of Cards&Payments.
Marilyn Landis spent much of 2007 expanding her business. Landis, president of Basic Business Concepts Inc., a Pittsburgh-based consulting firm for chief financial officers, had hired two staff members and opened two additional offices. She used her Bank of America Corp. business credit card to purchase some $5,000 worth of computer equipment.
On her BofA business cards, she charged more than usual for travel expenses to visit clients around the Northeastern United States and in cities where she was opening the two branches. Clients would reimburse Landis for many of her travel expenses, and Landis says she planned to pay off the balance for her computer purchases during the several months that her BofA card's introductory rate was to remain at 3.99%. Landis always paid the minimum or more on her balances each month and never paid late, she says.
In normal times, many business card issuers might have welcomed Landis' interest-bearing but timely payments as responsible use of revolving credit that earned them a little extra profit. But times have changed. Commercial card issuers are nervous about restrictive legislation and the potential for the current recession to trigger more delinquencies and defaults, and many are changing how they manage business card accounts accordingly, sources tell Cards&Payments.
In December 2007, BofA informed Landis it was increasing the annual percentage rate on her BofA card from 3.99% to 27%. The rate hike applied only to new purchases, not to her existing balance, but Landis considers it an unreasonable interest rate nonetheless (
"They said my credit score had changed because my other credit cards were getting close to their limits," Landis says of BofA's explanation for the increase.
Around the same time, American Express Co., with whom Landis has held a consumer credit card since 1989, notified Landis it was halving her credit line, which AmEx had recently raised to $11,400. The letter told Landis AmEx based the decrease on its assessment that she was carrying too high of a revolving balance on her AmEx and other cards, that she had too many recent credit inquiries and that she recently opened other accounts in the past year. Another reason for the credit decrease, AmEx said, was "our analysis of the credit risk associated with customers who have residential loans from the creditor(s) indicated in your credit report," according to Landis.
A Plea To Congress
Landis told her story to members of the U.S. Senate Committee on Small Business and Entrepreneurship in April in her capacity as chair of the National Small Business Association. Landis would rather not rely so heavily on credit cards for business debt, but small-business loans have become increasingly difficult for entrepreneurs to obtain, especially businesses such as hers that do not hold many physical assets to front as collateral, she tells Cards&Payments.
BofA has reason to be nervous about the health of its small-business credit card accounts. The issuer in October reported that its net charge-off rate on small-business loans issued in the United States, including credit cards, had risen to 10.64% of receivables in the third quarter ended Sept. 30, up 526 basis points from 5.38% during the same period in 2007.
AmEx representatives did not provide an interview for this article. But during a conference call with analysts in October regarding the company's third-quarter earnings, Daniel Henry, AmEx executive vice president and chief financial officer, confirmed the issuer is holding a tight rein on small-business card spending.
"We continue to acquire cardmembers with positive economics, and we encourage creditworthy cardmembers to spend. But we are managing small-business spending very closely," Henry said. "Credit operations is limiting or stopping spending on customers with high probability of default."
Executives of Advanta Corp., a U.S.-based issuer that specializes in small-business credit cards, have described in even more detail how they are changing the way they manage the issuer's portfolio.
"So much has changed in the world, it would be folly to believe we could continue to manage and organize our work the same way we did a year or two ago," Dennis Atler, Advanta chairman and CEO, told analysts during a conference call in October to discuss third-quarter earnings. (
The issuer has reorganized itself "to better align our efforts against three disparate groups that make up our portfolio," Atler said. Those groups include those that generate very high profits for the issuer, those that generate "good-to-excellent" profits, and those that are "relatively high risk, unprofitable or marginally profitable."
Advanta will embrace and work to nourish and grow the two profitable groups, according to Atler. "The last group will be segregated, sequestered and surrounded, and we expect our exposure to them will be reduced greatly in a variety of ways," he said. "We believe that managing these groups separately and having a discrete team dedicated to each group will enable us to best meet their particular needs and ultimately maximize the benefits for the company."
Advanta gained from Landis what she contends was a significant amount of business card revenue, according to her Senate testimony. In November 2006, she received a cash advance on her Advanta card of $14,318. She paid a $50 fee and 11.49% interest on the advance. Landis paid the $455 minimum due on the balance on time each month, but her December 2006 bill showed the interest rate for cash advances on the card increased from 11.49% to 20.01%.
"Equally surprising was that my average daily balance, for which I was paying 2.99%, had dropped to $1,779.86, while the rest of my outstanding balance, for which I was paying 19.99%, jumped up to $17,333.50, with no explanation," Landis
testified.
Such changes to terms of business card accounts make it difficult for company owners to plan responsible debt management and repayment, she says.
Not Alone
Landis is not alone in her complaints about changing business card terms and shrinking credit limits. According to the National Small Business Association, more small-business owners use credit cards as a source of financing than they do any other source of funding. But the association reported in December that 57% of small-business owners say their credit card terms were worsening.
In a statement released in December, Todd McCracken, president of the National Small Business Association, praised the approval in December of new Unfair or Deceptive Acts or Practices rules by the Federal Reserve Board, National Credit Union Administration and Office of Thrift Supervision. The rules apply to consumer credit cards, not business credit, a Fed spokesperson confirms. But many small-business owners use personal and business credit to cover business expenses.
Association members are disappointed the rules will not go into effect until July 2010, but its members are pleased the rules address many of the card-industry practices small-business cardholders consider unfair, McCracken said.
Business groups outside the U.S. also are calling for government to more-tightly regulate practices of business card issuers.
"We know that entrepreneurs use both personal and company credit cards to finance their businesses," John Wright, national chairman of the Federation of Small Businesses in the United Kingdom, wrote in his New Year message for 2009. "Over 26% use their personal credit card, and over 23% use their company credit card."
Given that the Bank of England base rate (interest the central bank charges on loans to other financial institutions) has dropped to 2%, its chancellor and governor "must and can take a very serious look at capping of interest rates charged on credit cards," Wright continued.
The call from the federation came weeks after UK issuers, facing pressure from the government, said they would tweak rules to allow cardholders more time to pay card debts and to protect consumers from sudden interest-rate increases.
Wright also called for banks to release more credit to "viable" small businesses, especially given the "billions of pounds poured into" British banks in recent weeks as part of financial-aid programs.
Though the Bank of England's base interest rate has dropped, card-lending costs have not necessarily followed suit, according to payments association APACS, a group that represents UK issuers. "Although base rates have recently fallen sharply because of the way credit card lending works, the risk of lending has not fallen and may have actually increased," says an APACS spokesperson in response to Wright's comments.
Credit card annual percentage rates represent the total cost of credit being granted, including the cost of operating an open-ended line of credit and the costs of managing bad debts and fraud. Therefore, "base rates are only one factor in the calculation of an APR," the spokesperson notes.
"In discussions that the credit card industry has recently had with government around best practices, the level of APRs has not been up for debate," she continues. "Having said that, anyone lending money in these exceptional times should be willing to actively explore best practices, and we exhort small businesses who are relying on their credit cards to speak to their credit card companies."
Landis says she understands the need for business card issuers to carefully manage the risks of revolving credit. "But they're evaluating my credit card use for business as they would for a consumer," Landis says. "They've chosen not to base their credit on the cash flow of my business."
In fact, issuers of credit cards to small businesses typically consider the personal credit health and habits of business owners in their decisions about how much and how to lend, says John Ulzheimer, president of consumer education at Credit.com Educational Services LLC. "It's not only appropriate but perfectly legal for the business lender to delve into the business owner's personal credit reports and scores to help them make decisions on how to manage their accounts," Ulzheimer says. "No one likes that, but that's the way it is right now."
Preventing Future Growth?
Edmund Tribue, global practice leader for the risk management practice of MasterCard Advisors, agrees that assessing personal credit of small-business owners is appropriate given that small-business owners often draw from personal and business accounts and credit for business expenses.
However, issuers are doing their customers and their own bottom lines a disservice by overreacting to economic turmoil in recent months, he says. "Their knee-jerk reaction is to pull back and protect themselves from losses, but it's going to be at the expense of future growth," Tribue says.
Community banks are doing a better job of managing small-business credit card risk because they have closer relationships with their customers, Tribue says. But even large issuers can use common sense to determine whether a spike in spending and balances on a business card is a sign of trouble or is normal given business expansion or the seasonal nature of a business' spending needs, he says.
For example, an issuer may reasonably be concerned about a sudden spike in the credit card balances of a small electronics store, but seasonal spikes in credit use, even for large cash advances to meet payrolls, are normal for many small landscaping companies, Tribue says. (
Tribue recommends issuers call business cardholders to discuss changes in credit card use instead of assuming the worst and automatically lowering limits or canceling accounts. Those issuers may be able to offer cardholders card or noncard loans that are more appropriate to the type of spending, thereby enhancing cardholder loyalty and ensuring future profits from transaction fees and interest, he says.
Getting Issuers' Attention
Many issuers have the tools to analyze cardholder behavior but do not use them to their full extent, according to Total System Services Inc., or TSYS, a U.S.-based processor that helps issuers manage several types of cards, including commercial cards. TSYS offers issuers a variety of software services to manage risk on originating and continuing card accounts, including links to such credit-reporting agencies as Dun & Bradstreet Corp. and Fair Isaac Corp. Issuers may program TSYS software to allow, flag or deny credit based on the their own analysis of the credit data it gathers.
Decreasing credit scores rightly gets issuers' attention, says Dale Davey, TSYS senior director of value-added products. But many issuers also look for more-detailed indications of how business cardholders are managing their credit lines: "What are you spending your money on? Is it purchases, or is it cash?" Davey says.
Moreover, many issuers have been closing consumer credit cards or reducing their limits because cardholders do not use the card often enough to justify the costs of guarding the card against fraud, Davey says. He expects more business card issuers to follow suit. "Why deal with the liability if they're not going to use it?" he adds.
Despite a challenging economy, issuers still have plenty of room to grow their small business card portfolios, says Ken Paterson, principal analyst at Mercator Advisory Group Inc., a U.S.-based consultancy.
"In spite of the current economic environment, it's still a very attractive segment," he says. "Issuers that do a good job managing existing relationships and originating new account relationships during difficult times are going to be in the best position to grow when the economy improves."
Issuers with deeper relationships with small business owners, through business and personal demand deposit accounts and other types of loans, are best able to cross sell those business owners appropriate business card products, including credit, debit and charge cards, Paterson says . "Small-business credit cards that are originated through those branch-based relationships tend to perform better from a credit standpoint," he says.
Many small-business owners try to avoid all types of debt, including revolving credit cards. But issuers could do more to encourage charge card use and to nudge depositors to make better use of the debit cards tied to their business checking accounts, he adds.
As for Landis, she is making minimum payments on her business cards and putting the extra funds she would have paid issuers into deposit accounts as reserves for business expenses. She advises many of her clients to do the same.
"It galls me when I see it," Landis says of the extra interest expense. However, she considers the strategy necessary for keeping funds accessible in case of further credit line decreases.
While Tribue agrees managing the cost of credit is important, he also agrees with critics who complain U.S. banks have not increased consumer and business lending after having received part of the expected $700 billion assistance under the federal Troubled Assets Relief Program. Unfreezing credit would be good for issuers and businesses alike in the long run, Tribue contends.
"There's a valuable service these small businesses provide to the overall economy," he says. "Issuers should realize it's a symbiotic relationship."
Economists expect card issuers and the businesses they serve to face continued economic challenges in the coming months. Finding the right balance between credit risk management and customer service will be part of that challenge. CP
