U.S. small businesses enjoyed access to capital and low interest rates for more than a decade before COVID hit. A combination of the economic shutdown during the pandemic and the inflation that accompanied the swift recovery have caused a small business credit crunch with a double whammy. Firstly, banks simply are less willing to lend – especially after the collapse of both Silicon Valley Bank (SVB) and Signature Bank and problems at other midsized banks. Secondly, interest rates have climbed to their highest levels since 2007.
It is getting harder to access funding, and when business borrowers are approved, they are paying a much higher cost of capital than they did in recent years.
In the Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) of April 2023, which polled 65 domestic banks and 19 U.S. branches of foreign banks, reported “tighter standards and weaker demand for commercial and industrial (C&I) loans to large and middle-market firms as well as small firms over the first quarter.”
Banks reported tightening lending policies for all categories of CRE loans over the past year. Frequently, they reported changes pertaining to wider spreads of loan rates over banks’ cost of funds and lower loan-to-value ratios.
Many banks reported tighter lending standards or terms cited a less favorable or more uncertain economic outlook, reduced tolerance for risk, worsening of industry-specific problems, and deterioration in their current or expected liquidity position as the reasons for cutting back on lending. It is worrisome that banks widely reported expecting to tighten their lending standards over the rest of this year.
The latest Biz2Credit Small Business Lending Index™ for April 2023, released on May 9, found that small business loan approval percentages at big banks slipped again, falling from 13.8% in March to 13.5% in April. Further, the approval rates of business loan applications at small banks dropped from March’s disappointing figure of 19.1% to 18.7% in April. Credit unions’ small business loan approval percentages also dropped last month, falling to 19.8% in April, from 20.2% in March. The takeaway is that less than one-in-five businesses were able to secure funding from banks or credit unions in April 2023.
As small business lending at banks and credit unions continues to decline, approvals at non-traditional lenders rose in each of the categories monitored by the Biz2Credit Index. Alternative lenders climbed to 28.7% in April, up from 28.4% in March. That’s a far cry from December 2013, when alternative lenders granted 67.3% of funding requests. Institutional investors granted 26.7% of applications in April 2023, up from 26.5% in March. While that figure is slightly better than what banks report, the number is down significantly from pre-pandemic high of 66.5% in February 2020.
The instability in the banking system goes well beyond the recent SVB and Signature Bank. Recently, First Republic Bank, a bank that was run much more responsibly than SVB, was taken over by the FDIC, and its assets were sold to JPMorgan Chase. Other midsize and regional banks may also be in trouble as business accounts continue to withdraw their money and shift it to big banks or money market accounts.
While we do not have a full bank run yet, these developments hurt the banks’ ability to make small business loans. The FDIC insures deposits up to $250,000, which is a relatively small amount for commercial accounts and leaves some deposits uninsured. The vast amount of uninsured deposits in the banking system raises the likelihood of bank runs in the future. This is bad not only for small businesses, but for the economy as a whole.
Complicating the financial woes of small firms is the ever-rising cost of capital as the Fed raised its base lending rate another 25 bps up to a range of to 5% to 5.25% at its May FOMC meeting. While the central bank is signaling that this may be the last increase this year, right now, interest rates are at their highest levels since 2007. It is encouraging that Fed Chair Jerome Powell suggested that the central bank might pause its rate hikes and study the impact of the rapid increases over the course of the past 12 months.
Total nonfarm payroll employment rose by 253,000 in April, and the unemployment rate dipped slightly to 3.4%, according to the Jobs Report released by the Bureau of Labor Statistics on Friday, May 5, 2023. Meanwhile, the low unemployment rate keeps pressure on wage inflation, which grew 4.4% in April from a year earlier. Employment continued to trend upward in several industries, including professional and business services, health care, leisure and hospitality, and social assistance. Many of these jobs are created by small businesses.
While it is good news that people are working, the tight labor market and resulting wage pressure hurts the bottom line for small businesses. Companies that need working capital to pay their bills are paying a higher cost of capital for it. This combination puts stress even on small businesses that are thriving.
There are some positive signs, however. Inflation slowed in April to its lowest annual percentage rate (4.9%) in two years. By comparison, the figure was 9.1% in June 2022. If the Fed halts its trend of raising its base interest rates, it will be a welcome relief. Importantly, if stability comes back to the midsize banking market, the latter half of 2023 could be a brighter than the beginning of the year.
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