Despite increasing interest rates and credit balances, banks are facing a more challenging business environment today.
That’s because late payments and defaults are also increasing, and unfortunately, that’s happening at an even faster pace compared to previous years.
Our weak economy is also impacting consumers and small businesses as well. Since they don’t have the massive war chests and easy access to credit that banks and Fortune 500 companies do, they’re impacted earlier and more significantly. In other words, they play the proverbial canary in the coal mine role. They also don’t have as many levers to pull, compared to larger corporations, when things get tough.
That’s why I wasn’t surprised to see these recent changes in the banking industry. In fact, I predicted it about two years ago when I started seeing the signs in my consulting practice.
I work with business owners who are trying to scale or exit, and solid financials are the foundation of these goals so that’s where I always start. And for the last several years, I’ve been noticing weaker financial health across a wide range of industries, showing up as declining revenue, slower paying customers, unpaid invoices, and a growing debt.
And it’s not just tiny companies. As you’d expect, companies generating a few hundred thousand to a few million in annual revenue are typically in the worst position, but I’m seeing this at larger companies in the $10-50 million annual range a lot more over the last few years now too.
Despite what the media claims, today’s weakening economy is hurting businesses at all levels.
Banks are now finally feeling the pain that millions of other companies have been facing for years, and they’ve gone into triage mode to mitigate the impact on their bottom line.
One lever that’s already been pulled is underwriting, which has tightened significantly in recent years.
The days of fast, easy, and inexpensive credit are behind us and likely won’t return in the foreseeable future. When the economy contracts, lenders seek to reduce losses by rescinding credit for riskier borrowers. It’s a logical move, but it leaves a lot of borrowers—including business owners, in a tight spot with fewer options.
This is decided by a borrower’s credit score, which is the result of a complex algorithm that determines their likelihood of defaulting. Admittedly, it’s not a perfect system, but it’s unfortunately the best that exists. What this means in real world terms is that borrowers who have never had a single late payment may suddenly have their credit limits cut simply because an algorithm indicates they’re a greater risk than borrowers with a higher score.
Ari Page, business credit expert and founder of the consulting firm, Fund&Grow, says this is not punitive, but rather an economic formula lenders must operate on.
“People don’t really understand how the lending industry works, and that leads to a lot of misconceptions. Lenders have to first borrow money which they have to pay interest on, and then they have to ascertain risk among the potential borrowers they’re lending it out to. Their profit comes from the additional interest they charge borrowers—but what most people don’t understand is how precarious this model really is,” he explains. “A single default not only means the lender loses money on that borrower, it often also wipe out the profit from borrowers who made all of their payments on time. Things can spiral out of control pretty fast,” he says. Page broke this down in more detail in a recent interview with Fox 13’s Blake Devine.
While the situation is understandable, it also means consumers lose a valuable lifeline for unexpected expenses like automotive repairs, medical expenses, or living expenses after a job loss. The same applies to business owners, who often rely on access to business credit to purchase inventory, materials, and crucial services.
Losing access to this lifeline can unleash a financial catastrophe.
And on the other side of the coin, Federal regulators are more aggressively cracking down on marketers misrepresenting the credit products they’re promoting. Business credit card stacking is a key focus.
This is a process where a business owner will apply for multiple business credit cards, usually focusing on ones offering a 0% introductory APR, to acquire between tens of thousands to hundreds of thousands in business credit that doesn’t show up on their personal credit profile. This is legal, legitimate, and more common than most people realize.
It’s also widely misrepresented by some marketers, and Page says he wants to fix that.
The Federal Trade Commission recently started holding some of these deceptive marketers accountable through a series of high profile cases, including a $48 million judgment against Seek Capital, a $2 million judgment against Seed Consulting, and a $15 million judgment against Nudge LLC. Federal officials indicate that more of this type of enforcement is coming.
“Marketing is the area where I see business credit card stacking companies ignore consumer protection laws the most. They’ll often misrepresent the service they’re offering, framing it as a business loan rather than business credit cards, act as if they’re the lender, or even just apply on their customers’ behalf without doing anything substantive to help maximize their clients’ results,” Page explained in a recent interview with International Business Times.
Marketing is public, and often, even searchable through ad platforms like Facebook, making it easy for regulators to find companies that are running afoul of the law. Misrepresenting credit cards as “loans” or promising to “convert credit to cash,” are common tactics, yet both are also egregious examples of violations of both federal regulations and the terms of service from credit card companies like Visa, Mastercard, and American Express.
With so many willing to violate these laws in such a public environment, experts like Page warn that it’s even worse behind the scenes, and that’s one of the reasons he’s been working to launch a self-policing regulatory association for his own industry.
While the FTC is focused primarily on companies misrepresenting business credit card stacking services, the credit card companies are coming after them as well as the business owners misusing their financial services either knowingly or unknowingly. That can create real problems for entrepreneurs.
“I’ve seen lots of entrepreneurs get duped by slick marketers who misrepresent the products and services they’re offering when it comes to business credit. That can create a devastating financial situation on its own, but that’s often not the end of their problems. If an entrepreneur is found to be in violation of the credit card or merchant account companies terms of service, I’ve also seen their zero APR rate pulled, their accounts get terminated, and in some cases they even get blacklisted preventing them from opening new accounts.Imagine how it would impact a small business if they were suddenly unable to process credit card payments—that would destroy most companies overnight,” Page explains.
As the economy continues to weaken, banks will continue to tighten both underwriting and regulations, and at the same time, Federal regulatory agencies seem committed to cracking down on non-compliance, so entrepreneurs need to be aware and prepared. Equally important, they need to be more selective than ever in regards to the businesses they chose to work with.
This is so much bigger than compliance—it’s a matter of survival.