A line of credit can be a lifesaver for an entrepreneur, providing a buffer against cash-flow problems and making it easier to handle recurring expenses such as payroll. But beginning in March, according to documents obtained by BusinessWeek SmallBiz, JPMorgan Chase suspended credit lines for a large number of business owners. According to someone familiar with the matter, the move affected thousands of businesses that had been clients of Washington Mutual before Chase bought the ailing bank in September 2008. The documents show that Chase tasked a special group inside the bank with responding to inquiries from borrowers whose lines of credit were being suspended.
The bank can expect plenty of those, at least partly because in many cases, the businesses whose lines were cut had not missed loan payments. Instead, their credit score or their financials had deteriorated, and credit-line agreements typically give banks the right to alter the terms of the line if there is a change in the borrower's financial situation. In this case, the changes are dramatic. If business owners can't convince Chase of their creditworthiness, they have three options: pay off the balance in full; agree to a conversion of the line of credit into a term loan; or go into default.
The fallout for affected business owners can be severe. Those who accept the conversion to a term loan will likely see dramatically higher monthly payments. A business owner may be able to keep a line of credit open with interest-only payments, but term loans typically have to be paid off—interest and principal—within three to five years. Plus, they may carry higher interest rates. At the same time, while small lines of credit are often unsecured—so no business assets are pledged against the line—term loans may come with a lien against assets of the business. That will make it tougher for the business to get new financing from other sources since it may require the bank to relinquish its first claim on things like accounts receivable. Even if a business owner has the line cut but not converted to a term loan, he or she in effect is drawing down a greater percentage of the line, a factor that can drag down a credit score.
Thomas Kelly, a spokesman for Chase, says the bank continually reviews the lines of credit in its portfolio. "We contact customers if we determine there has been an adverse change in their financial condition or credit history. We may eliminate the unused portion of their credit line and set up a standard repayment plan." Kelly says the bank encourages customers to contact Chase if they want the decision reevaluated or if they want to provide information such as their federal tax return. And he says the bank has assigned staff to work with customers who want such decisions reexamined.
Analysts say the recent move is in keeping with Chief Executive Jamie Dimon's track record. When Dimon became CEO of Bank One in 2000, Rochdale Securities analyst Richard Bove says, "the first thing he did was cut off lending to middle-market companies and small businesses." Bove says this hurt Bank One when the economy picked up. "These companies didn't want to deal with Bank One. The small business market is profitable, and Chase will care. There is a business risk."
Donald Raftery, managing director at Greenwich Associates, a Stamford (Conn.)-based financial-services consulting firm, says many banks, overwhelmed with problem loans, are "trying to take a very active approach on a broad segment of companies. There's no individual type of approach. [Small companies] feel like they're being treated like a number."
Mark Fitchett, the owner of $300,000 music school operator L&M Music in Long Beach, Calif., would certainly agree. He had been a Washington Mutual customer before the bank was acquired by Chase. He had four overdraft lines of credit of $10,000 each, one for each of his schools and one for the parent company, and has been drawing on them at the beginning of each month to help pay the music instructors that contract with his company. In late April, Fitchett was checking his account online and noticed that two of the lines—those for his Peninsula School of Music and The Guitar School—were not showing up. That day a letter arrived saying that, due to an adverse change in his "financial condition and/or credit history," Chase was blocking him from drawing on those two lines. Fitchett said he called Chase, but still doesn't understand what prompted the move. He's now trying to land a line with a different bank. "I'm thinking now about how I'm going to cover the first week [of paychecks] in time," Fitchett says.
The phenomenon may extend well beyond Chase and its borrowers. "I'm hearing it more and more," says Stacey Sanchez, senior community loan officer with San Diego-based CDC Small Business Finance, a community development corporation. She says entrepreneurs often turn to her institution when their credit lines are pulled. Sanchez says the increased aggressiveness on the part of lenders may be due in part to the fact that banks now are in possession of 2008 tax returns for most of their clients, which show the full ugliness of the last quarter of that year. Others argue that it also reflects a return to more prudent lending standards. Ed Lette, chairman and CEO of Austin (Tex.)-based Business Bank of Texas, says big banks skimped on due diligence when extending credit to small companies, often relying only on credit scores—which reflect past creditworthiness—rather than an examination of the company's current financial condition. "Bankers are lemmings," Lette says. "They were lazy and allowed this to happen."
Now they're retrenching. In April, the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices showed that banks had tightened standards on small firms for the tenth consecutive quarter. Some 30.7% of banks said they had trimmed credit lines for small companies.
Suspending lines of credit is certainly an efficient way to reduce the risk on a bank's balance sheet. According to officials at the Office of the Comptroller of the Currency, bank reserves for bad loans are based on total exposure to a customer. So if a bank gives a $100,000 line of credit to a small firm and only $20,000 is drawn down, the total exposure is still $100,000, and the bank usually will reserve for loan losses based on $100,000. But if the bank converts the $20,000 to a term loan and cancels the line of credit, or if they simply cut the line to $20,000, the necessary reserves would be based on the $20,000 figure.
Regulatory pressure likely plays a part as well. Bert Ely, an Alexandria (Va.)-based financial-services consultant, says he hears repeatedly from banks around the country that while the White House and Treasury talk about the need to lend to small business, local bank examiners continue to pressure banks to upgrade the quality of their loan portfolios. "You have a disconnect between what policymakers are saying and what the rank-and-file bank examiners and supervisors are saying," Ely says. That has painful repercussions for business owners around the country.