Credit Crunch for Small Business Cardholders

May 16th, 2009
Complex and Interconnected

Complex and Interconnected

At the end of last year, Advanta Corp. was the 11th largest U.S. credit card issuer with approximately $5 billion in outstanding balances and the only major credit card company focused on the small business segment.  More than one million of those small business customers are searching for new sources of credit as Advanta will stop lending against credit card accounts on June 10, 2009. The stated reason for this action was that uncollectible debt reached 20% of the total outstanding, according to public filings of the company. Advanta has set aside $1.4 billion to buy back securitized credit card loans at 65 – 75 cents on the dollar.  Advanta finds itself caught in a squeeze: it has been unable to sell its receivables for cash in the asset-backed securitization market since June 2008 and rising unemployment rates suggest further deterioration in their credit card receivables. William Dunkelberg, chief economist of the National Federation of Independent Businesses, questioned how many business owners depend solely on their Advanta credit card and noted that credit is harder to find than ever before.

As I had advised in Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition, 2008), mitigate your risk of third party failure by diversifying your suppliers. Never rely on a single provider, unless it is absolutely unavoidable, which was certainly not the case with U.S. credit card issuers.

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Storms Leave 150,000 in Missouri Without Power

May 12th, 2009
Power Outages Affect Us All

Power Outages Affect Us All

This weekend, hundreds of homes and businesses were damaged or destroyed in Kansas, Illinois, Kentucky and  Missouri as a result of powerful storms. The Governor of Missouri declared a state of emergency as 150,000 residents of his state were without power. This is a timely reminder to evaluate your protection against power outages, starting with the protection of computers and data. Even when electrical power is available, there are quality issues, like peaks in voltage as well as micro-outages. Since IT equipment is sensitive, use an uninterruptible power supply unit (UPS), which is usually a surge protector, together with a small buffer battery that would supply energy for about 10 minutes after the electricity supply is terminated, enough to finish important work and to shut down the system. Most units support an automatic shutdown before the battery is completely depleted. Some buildings supply self-generated backup power. Please note that this power is usually much “dirtier” than power from the outlet. Under these circumstances, you must use a UPS unit, preferably one that is designed to smooth out erratic electricity supply.

Certain high-rise apartment and office buildings have back-up generators that provide low levels of power for up to fourteen hours after termination of the central electrical supply. Many workers and residents of these buildings mistakenly believed that a volt of electricity is a volt of electricity irrespective of whether it comes from the central utility or a back-up generator. During a recent power outage, they used their home and office computers with electricity delivered from a back-up generator, without the benefit of a UPS unit, and damaged their computers in the process. Also, remember to turn off appliances and equipment during a power outage as power supply may be erratic when it is initially restored.

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Global Similarities, Part Two

May 11th, 2009
An Uphill Battle

An Uphill Battle

In an earlier blog posting, I wrote of the difficulties small businesses in the United Kingdom were experiencing with respect to access to credit, even in obtaining loans from banks that had received government assistance. It isn’t just the Anglo-Saxon countries where the flow of credit to small businesses is blocked. Zwanzig Minuten (a daily newspaper, the title means “Twenty Minutes”) reports that the Swiss government is establishing a loan fund to aid small and medium enterprises throughout the country with loans of up to CHF 40,000.  We tend to think of the large corporate enterprises as dominating employment in Switzerland, particularly the banks and pharmaceutical companies. In fact, in Switzerland, as in the United States, small businesses account for more than one-half of all employment. The Swiss economy is also in recession, with economic contraction of 2.2% projected for this year. Switzerland also had its version of a government bailout: UBS (Union Bank of Switzerland) accepted government assistance, Crédit Suisse did not. And, consistent with the trend we have seen, Swiss small businesses are also struggling with issues around access to credit. I lived as an ex-patriate in Zurich, Switzerland; this photograph is the famous Matterhorn, perhaps symbolic of the tough obstacles small businesses everywhere face.

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Swine Flu, the Sequel

May 10th, 2009
Global Connections

Global Connections

In a previous blog entry, I wrote about swine flu motivating small businesses to consider telecommuting options, for employees for whom this arrangement is feasible. This could both slow the spread of the illness, by keeping people out of crowded workplaces and public transport, and allow employees to stay home and care for their infected loved ones, where necessary. Establishing procedures for working from remote operations, such as data storage and network security, is critical for all types of disasters, from fires to civil emergencies. And now there is another reason to look into telecommuting. While the swine flu appears to have slowed down its rate of new infections, it may be poised for a second wave of infections in six months’ time.

I remember reading the book about the influenza epidemic of 1918 (when you work in the reinsurance industry, you focus on many cheerful topics). One-fifth of the world population was ultimately infected with the flu, but this damage was inflicted largely in a second round of the virus, six months after the first one. And with the travel patterns in our global economy, an epidemic in this era would become a pandemic more readily.  Public health officials are now predicting that history might repeat itself and we should prepare for a second outbreak in the winter. Doctors report that the warm temperature of the summer months is not conducive to spreading the virus; the next threat will likely occur in the winter months. So let’s take advantage of what may be a six-month reprieve to prepare our small businesses for temporary remote operations and know that the effort will pay off, irrespective of what happens with the flu.

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Across the Ocean, Things Are Much the Same

May 9th, 2009
Global Similarities

Global Similarities

In earlier postings, I wrote of the possible appearance that the small business stimulus appears to involve substantial, undisclosed risk to the taxpayer and that the SBA loan program to emerge from the stimulus bill has limited benefit for small businesses. This appears to be a universal theme.

In the United Kingdom, the Treasury Select Committee, a group of politicians representing each of the political parties, produced a 121-page analysis of the collapse of the banking sector. The analysis relied on interviews with government ministers, including Treasury Minister Alistair Darling and bankers. Not surprisingly, the report was critical of the failure of regulators to prevent the collapse of the largest banks in the U.K. including Royal Bank of Scotland. The Committee also noted that they were “very concerned” about the lack of credit for small businesses that also faced higher charges and arrangement fees. Specifically, the report stated “We deplore the behavior of a number of those banks who have received so much public money and behaved in such an insensitive manner particularly to established customers”. The Committee demanded that banks that received had taxpayer funds provide more disclosure as to their loans to the small business sector.

The findings of the Treasury Select Committee contradicts a report published one week ago by the British Bankers’ Association which claimed that lending to small businesses rose 5%, or more than £270 million, year-on-year. The British Banking Association further stated that small business lending rose in each of the three months of the first quarter of 2009.

As small business owners, irrespective of where we are, we face similar issues in dealing with big businesses and with big government. In writing Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses, I tried to be a inclusive as possible, to serve the needs of a global small business audience, while also offering specific, actionable advice. There were fewer than five pages of the book in which I discussed information unique to an American audience; specifically, the programs of the U.S. Small Business Administration and the Federal Emergency Management Agency. But I had hoped that there, too, the information would have broad relevance as, while policy specifics may differ from country to country, the underlying risks inherent in dealing with government agencies are the same. I had hoped that readers outside the U.S. would also find the lessons helpful and applicable to their specific circumstances. I hope to see Prepared Small Business build a global network of resilient small businesses as we have much to learn from one another, whether in dealing with access to credit or other issues.

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Sit Tight and Follow the Fortune 500

May 8th, 2009
Follow the Fortunes

Follow the Fortunes

In a previous entry, I wrote about anticipated increases in property-casualty insurance premiums. Reinsurance broker Guy Carpenter, published a report Cats and Credit Push Prices Up: Global Reinsurance Review January 2009 in which it found that property casualty rates rose only 11% across the United States this year. You may wince at the word “only”, but this rate increase is dampened as compared with what followed Hurricane Andrew in 1992, the terrorist attacks of September 11, 2001, and Hurricanes Katrina, Rita and Wilma in 2005. This is remarkable given the level of catastrophes (close to $20 billion in insured losses) in 2008 and the financial losses on the investment portfolios of insurance companies. The rate hikes could have been much, much worse. What typically happens after two or three annual renewal seasons of increasing rates is that the Fortune 500 will seek alternative means of financing their risks at lower costs. This might include self-insurance through corporate captives, for examples. Four states – Michigan, Missouri, Louisiana and Connecticut – are enacting legislation similar to the statutes in Vermont to establish captive insurance companies in their jurisdictions or to persuade existing captives to re-domicile. The recent announcement of President Obama concerning increasing scrutiny of offshore corporate vehicles (corporate captives are commonly found in places like Bermuda and the Cayman Islands) may accelerate this trend. What this means is that supply and demand will eventually favor the small businesses. As large corporate insureds withdraw from the expensive primary insurance market in favor of less expensive alternative risk financing vehicles, demand declines and price follows. Small businesses can then purchase their insurance at lower costs. In other words, sit tight, Fortune 500 companies will soon look to cut their insurance expenses and we will benefit from the lower prices that follow their actions.

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Watch Your Workers Compensation Costs With Extra Care at This Time

May 7th, 2009
It Escalates!

It Escalates!

An economic and financial crisis is a non-natural disaster and poses different risks to small business workers compensation. The first is cost-shifting. The National Council on Compensation Insurance reports that medical losses constitute more than one-half of total losses attributed to workers compensation insurance. An employee who is without medical insurance would easily be tempted to report an injury as job-related in order to avail himself of the medical coverage. Likewise, as deductibles and co-payments rise, employees who are under financial stress may face the same temptation. The shift of medical costs to workers compensation insurance may increase the burden to the small business. I recommend mitigating this risk by using a higher-deductible medical plan (first dollar losses are always the most expensive) and then funding the deductible on behalf of the employee.

The second risk concerns fraud. I remember a discussion I had more than one decade ago with the chief financial officer of a major underwriter of disability income who reported the impact of pending healthcare reform in California. Specialist physicians faced caps on their reimbursement rates and so, the insurer was able to prove, injured themselves to benefit from own occupation provisions of their disability coverage and workers compensation insurance. I had a similar conversation with the chief executive officer of a top five underwriter who reported the same phenomenon. Unfortunately, this is what happens in times of economic stress. Mitigate this risk with careful product design: your benefit should cover medical, psychological and occupational rehabilitation with an emphasis on returning the employee to work.

The problem with these costs is that they tend to be “sticky”: the costs rise in an economic downturn, but when the economy recovers, they don’t fall back to pre-disaster levels. So the small business owner is locked in with higher experience-rated premium payments. In a tough economy, where we are all looking for cost savings, this is an important area.

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Unlimited Risks or Empty Gestures?

May 6th, 2009

In an earlier posting, I wrote of the complications of the Small Business Administration’s new loan program. New details have emerged that the risks may be greater than the public appreciates. SBA loans were the main topic at a recent town hall meeting at which President Obama noted that the annual volume of loans backed by the Small Business Administration was trending below $10 billion, down from $18.2 billion last year and $20.6 billion the year prior.

To stimulate the flow of credit to small businesses, the administration endorsed provisions in the stimulus bill. The legislation attempts to unblock the flow of credit to small businesses by temporarily raising government guarantees from 80% to 90% on the SBA’s flagship loan programs. In addition, it’s temporarily waiving SBA loan fees to reduce the cost of capital.

The Treasury now requires the 21 largest banks receiving funds under the Troubled Asset Relief Program to report their small business loan volumes on a monthly basis. Other banks receiving TARP funds must report this information quarterly. Treasury advised banks not participating in TARP that they too should make every effort to increase their small business lending. This push suggests that after the banks repay their TARP obligations, Treasury will continue to take an interest in SBA loans.

Critics of SBA programs charge that SBA loan guarantees create a moral hazard in incentivizing lending that’s harmful to U.S. taxpayers who must bear any losses. The most recent default rate reported on the SBA loan portfolio is 12%.

Further compounding the moral hazard risk is that some of the 21 largest banks have limited experience with small business lending. With the SBA principal guarantee on loans increased to 90% from 80%, taxpayers could potentially be underwriting a steep learning curve for the banks. Bank executives presumably appreciate how the public would likely assign blame for loan losses requiring additional taxpayer support.

This raises the question: is this a sincere effort to unblock the flow of credit to small businesses or an empty political gesture?

 

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Cash Flow Underwriting

May 4th, 2009
Harder Markets Ahead

Harder Markets Ahead

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (John Wiley & Sons Inc., second edition, 2008), I explained the cash flow of an insurance company (page 178):

“An insurance company collects premiums from its policyholders. such as your small business. It invests these premiums in assets, such as high-quality bonds and blue chip stocks, to earn investment income. It pays out expenses, such as premiums for its own reinsurance coverage, salaries to employees and so forth. It also pays claims to its policyholders for insured losses, or damages. The cash flow of an insurance company (premiums plus investment income less expenses less losses) is often expressed in terms of a combined ratio. The combined ratio is the sum of the loss ratio plus the expense ratio. A loss ratio of 100%, for example, means that for every dollar the insurance company collected in premiums, it paid out one dollar in losses and expenses. An insurance company with such a loss experience stays in business by engaging in so-called cash flow underwriting; that is, its insurance losses are more than offset by the investment income the insurance company earns on its premiums. In 1999, for example, insurance companies were paying out $1.07 in claims and expenses for every dollar collected in premiums. You can appreciate how sensitive the insurance industry is to the financial markets.”

When the combined ratio becomes unsustainably high, the insurance industry can no longer rely on cash flow underwriting and has to raise premiums. Insurance industry professionals refer to this as a “hard market”, one in which rates are rising. This graph here shows the combined ratio for the U.S. property-casualty insurance industry from 1970 through the third quarter of 2008. The horizontal grey line shows the combined ratio at 100%, that is when the insurance industry breaks even. The bars that extend above the grey line are shaded in blue and show when the insurance industry is underwriting risks at a loss and relying on investment income to remain profitable. The green bars are those that do not reach the grey line; that is, the combined ratios are below 100% and the industry is making underwriting profits.

The insurance industry had a particularly difficult year in 2008: for the first three quarters of last year, the U.S. property-casualty industry paid $19.9 billion for catastrophic losses. These losses occurred at a time when the financial markets were in decline, and so investment income was insufficient to compensate for underwriting losses. Hence, the bar for the first three quarters of 2008 is blue in color, extending above the grey line for a 100% combined ratio. This suggests that the insurance market is about to become “hard”, cash flow underwriting is about to end, and premiums will rise. Better to renew your insurance coverage sooner rather than later, as later it will likely be more expensive.

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Delays in the SBA Stimulus

May 3rd, 2009
Pushing Pencils, It Seems

Pushing Pencils, It Seems

In a previous blog entry, I expressed skepticism about the Small Business Administration’s forthcoming emergency credit facility, tentatively named “America’s Recovery Capital (ARC) Loan Program”.  The legislation enabling this program, the stimulus bill, requires the SBA to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”. Now there is another reason to question the value of this program.

A recently released  Government Accountability Office report announces that the Small Business Administration will be a few months late installing some new regulations meant to revive SBA lending, which has dramatically declined over the past year. Two changes mandated by Congress, including eliminating loan fees and raising loan guarantees for borrowers, were enacted in the required 15-to-30-day period. But the SBA failed to increase guarantees on secondary market real estate and equipment loans and to issue regulations involving “systemically important” broker-dealers in the secondary market in a timely manner. SBA officials stated that it was too complicated to enact such rules in the short period required by Congress and that they hoped to have these matters resolved by June.

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