Small Business Lending and the Recovery (NakedCapitalism)

MONDAY, JULY 12, 2010

Small Businesses Face Record Spreads, SBA Lending Cliff Dives in June, Boding Ill for Employment

Distressing news continues to accumulate on the small business front. Smaller companies have been particularly hard hit by the downturn. Some of that goes with the terrain, since small businesses are more fragile than bigger ones. Nine of ten startups do not survive their first ten years. Even in typical recessions, banks cut off lending (or reprice it to make it much more costly) to smaller enterprises to a much greater degree than big businesses (these are often across the board decisions, hitting all customers of a bank that fall into a particular category now deemed suspect).

In this contraction, small businesses have had it even worse than usual. Not only have the cutbacks to in business loans been ever more severe than normal, but other sources have been strangled off as well. For instance, companies too small to qualify for loans against the business often rely on business credit card products targeted to them, where borrowings might cost, say, 9% to 14% annually. Some players like American Express have canceled entire categories of small business products; many other banks have slashed credit lines, even to borrowers with pristine records who made little use of them.

This pattern bodes ill for the economy. Small businesses not only employ roughly half the workers in the US, but they created 60% to 80% of net new jobs each year in the past decade. Their owners have not been feeling terribly optimistic, and their confidence ratcheted down in June. The Wall Street Journal reported on the latest survey by Discover, which highlighted a rise in financial stresses:

….rising concerns over temporary cash flow issues offset some improvement in the way small business owners see the climate for their own operations.

“Many small business owners are working harder than ever to make payroll, pay their bills and keep their businesses running,” said Ryan Scully, a Discover director. “Last month, more owners reported increasing their spending, which is good news. However, if sales are lagging this month, it’s possible that cash flow was more of an issue.”…

In June, 29% of small business owners said they believe the overall economy is getting better, falling from 35% in May. Meanwhile, 51% said the economy is getting worse, steady from the previous month, and 16% see the economy as the same, up from 12% in May.

Their concern over cash flow management is well founded. The Financial Times reports tonight that small businesses are paying the highest risk spreads on record:

The Fed’s data show that in early May interest rates on small commercial and industrial loans, on average worth about $500,000, were 3½ per cent higher than the federal funds rate, the widest gap since the series began in 1986.

Yves here. While all-in borrowing rates may be cheap by historical standards, the high spreads suggest strongly that banks are also restricting credit (high spreads and high turn-down rates go together).

Reader Don B pointed out a New York Times business blog post that discussed how Small Business Association loans fell sharply in June as provisions to make programs more attractive to both borrowers and banks expired:

Total approved loans in the S.B.A.’s guaranteed loan programs fell to just $647 million for the month, down two-thirds from $1.9 billion in May, according to figures provided by the agency. It was the worst month for S.B.A. lending in years, perhaps decades. Even during the credit crisis that began in the fall of 2008 the S.B.A. approved more loan dollars than it did last month.

Bankers who work with the S.B.A. blamed the steep drop-off on the absence of stimulus measures that raised the guarantee level on general business, or 7(a), loans from 75 percent to 90 percent and also eliminated borrower fees on both 7(a) loans and so-called 504 loans, which are used primarily to finance capital investments such as real property. These provisions largely expired at the end of May….

Barry Sloane, chairman and chief executive of Newtek Business Services, a large S.B.A. lender that is not a bank, said that the lower guarantees meant that his company would itself have to borrow more money to make the same amount of loans. (A bank uses its deposits to fund loans; a non-bank lender has to find other sources of capital to lend.) The higher guarantee, he said, “is key to being able to lever borrowed capital.”….

Mr. Sloane said that because loans are typically funded 30 to 60 days after they’re approved, “if this continues, you’re likely to see a lot of businesses that don’t have funding in September and October.”

Yves here. Christmas-related spending is a big boost for much of the economy; businesses need to buy supplies and produce/carry inventory in advance of Christmas orders. Limited access to funding in the runup to this critical selling season would be particularly damaging.

ORIGINAL POST HERE