With the Federal Reserve’s latest interest rate hike, which increased the cost of debt by half a percentage point to its highest level in 15 years, most small business loans will see interest rates hit double-digit levels for the first time since 2007.
The cost of borrowing and paying monthly interest on business debt is already rising rapidly following successive mega-75 percentage point Fed rate hikes, but the 10% level is a psychological threshold that small business loan experts say will weigh on. many entrepreneurs who have never experienced such an elevated credit market.
Small Business Administration lenders are capped at a maximum spread of 3% of the base rate. With the Prime rate hike to 7.5% on Wednesday, the most common SBA loans will now exceed the 10% interest rate level. This is the highest Prime Rate since September 2007.
For veteran small business lenders, this is not a new experience.
“Prime was 8.25% in May 1998 when I started in SBA lending, 24 years ago,” said Chris Hearn, founder and CEO of small business lender Fountainhead.
The loans he made at the time were at the very usual Prime + 2.75% (then the maximum above Prime any lender could charge on an SBA loan), or 11%. But that was the norm, not a spike in rates in a short amount of time.
“In less than a year, we will go from a 5-6% range to a doubling, and it will have a huge psychological effect,” Hearn said.
The monthly interest payments that the owners will make are not much different from what has already become one of the main costs of the Fed’s rate hike on Main Street. Debt servicing during cost inflation and labor inflation forces business owners to make much tougher decisions and sacrifice margins. But there will be an additional psychological effect among potential new applicants. “I think it’s already started,” Hurn said. “Business owners will be very careful about taking on new debt next year,” he added.
“Every 50 basis points is worth more, and it’s undeniable that it makes a big difference psychologically. Many business owners have never seen double digits,” said Rohit Arora, co-founder and CEO of small business lending platform Biz2Credit. “Psychology matters as much as facts, and this could be a game-changer. Several people over the past few weeks have told me, “Wow, that’s going to be double digits.”
The NFIB’s monthly survey of business owners, released earlier this week, found that the percentage of entrepreneurs who cited funding as their top business concern hit its highest since December 2018, when the Fed last raised rates. Nearly a quarter of small business owners said they were paying a higher rate on their latest loan, the highest since 2008. The majority (62%) of owners told the NFIB that they were not interested in applying for a loan.
“The pain is already there, and there will be more,” Arora said.
This is because, once the psychological threshold of the 10% interest rate has been crossed, the Fed is expected to maintain high rates for an extended period of time. Even with a slowdown in rate hikes and a potential halt in rate hikes as early as early next year, there are no signs that the Fed will cut rates even if the economy enters a recession. The latest Fed review by CNBC shows that the market is forecasting a peak Fed rate of around 5% in March 2023, and that rate will be held at that level for nine months. Survey respondents said a recession, which 61% of them expect next year, will not change the “higher for longer” view.
This problem will be exacerbated by the fact that as the economy slows, the need for borrowing will increase for business owners facing declining sales, and they are unlikely to receive additional support from the Fed or the federal government.
Decreasing inflation from 9% to 7% is likely to be a faster change than reducing inflation from 7% to 4% or 3%, Arora said. “This will take a long time and will create even more pain for everyone,” he said. And if rates don’t come down before the end of 2023 or 2024, that means “a full year of high payments and low growth, and even if inflation does come down, it won’t go down enough to make up for other costs,” he added.
As economist and former finance minister Larry Summers recently notedthe economy may move into its first recession in four decades to see higher interest rates and inflation.
“We have a long-term problem,” Arora said. “This recession won’t be as deep as 2008, but we won’t see a V-shaped recovery either. The recovery from the crisis will be slow. quite a bit of time.”
Margins have already been hurt by the rise in the cost of monthly payments, meaning more business owners will be cutting business investment and expansion plans.
“Talks with small business owners looking for funding are starting to slow things down,” Hearn said.
There is now more focus on cutting costs amid changing expectations for revenue and earnings growth.
“It’s having the effect the Fed wants, but at the expense of the economy and the costs of these smaller companies that aren’t as well capitalized,” he said. “This is how we have to tame inflation, and if it hasn’t been painful yet, it will be even more painful.”
Margins have been squeezed due to the cost of monthly payments – even at a low interest rate, the annual default period for an SBA EIDL loan has now ended for most business owners eligible for this debt during the pandemic, adding to the monthly business costs. debt — and investment back into the business is slowing and expansion plans are being delayed.
Economic uncertainty will result in more business owners only taking out loans for urgent working capital needs. Ultimately, even core capital expenditures will suffer—if not already—from equipment to marketing to hiring. “Everyone expects 2023 to be a painful year,” Arora said.
Even in bad economic times, there is always a need for debt capital, but this will reduce interest in growth-oriented capital, whether it be a new marketing plan, new equipment that improves efficiency or scale, or buying a company down the street. “Demand for conventional business loans will continue,” Hern said.
The creditworthiness of business owners has not weakened across the board, but banks will continue to tighten lending standards next year. Small business loan approval percentage in large banks fell in November to the second-lowest in 2022 (14.6%), according to the latest Biz2Credit Small Business Lending Index released this week; and also decreased in small banks (21.1%).
One factor that has not yet fully manifested itself in the commercial lending market is the slowdown in the economy, but not yet reflected in the interim financial reports that lenders use to review loan applications. Business conditions were better in the first half of the year, and as full-year financial statements and business tax returns reflect a worsening economic situation in the second half and likely no year-over-year growth for many businesses, lenders will turn down more loans.
This means that demand for SBA loans will remain strong compared to traditional bank loans. But by the time the Fed stops raising rates, business loans could be at 11.5% or 12%, based on current expectations for the second quarter of 2023. has the same history as me,” Hearn said.