It is common to divide the US business ecosystem between wall Street why main road, If the first stage corresponds to large publicly traded firms, the second stage is used to refer to general businesses. While a rate hike by the Federal Reserve to appease inflation affects both, the latest one approved this Thursday by the central bank will be particularly damaging to small businesses.
The Fed’s decision to raise federal interest rates by 50 basis points (to a range of 4.25%-4.5%) adds half a percentage point to the cost of foreign capital, reaching its highest level in 15 years. Doomsday Is Fast Approaching: Most Small Business Loans Will Reach Interest Levels in double digits for the first time since 2007,
The cost of borrowing and monthly interest payments on corporate debt have risen sharply following consecutive Fed rate hikes since the spring of this year, but the 10% level is a psychological threshold Which, according to small business loan experts, will put a burden on many entrepreneurs who have never experienced this type of context.
This calculation is derived from what is known as the preferential interest rate or Prime rate, is the rate that US banks charge their low credit risk customers. This indicator serves as the basis for determining other market rates. With a 50 basis point increase by the Fed, that rate rises to 7.5%—the highest since 2007.
As small business lenders included in the reserves of small business administration (a government agency to support small businesses, the SBA for short) are limited to a maximum difference of 3% from this preferred rate, the Fed’s decision this Thursday will take them to 10.5%, the highest since before the great financial crisis. There is also the highest level. , Remarkably high level, despite the fact that access to loans under the support of this agency already offers small businesses more favorable terms.
The monthly interest payments that homeowners will make is not much different from what has become one of the main costs of the Fed’s rate hikes on Main Street. In the era of input and labor inflation, debt service is forcing businessmen to take very difficult decision and sacrifice margin. But there will be an additional psychological effect among potential new applicants.
“Entrepreneurs will be very careful while contracting new loans next year,” he says cnbc Chris Hearn, Founder and CEO of Fountainhead Lender. “In less than a year, we will double to the 5-6% range, which will have tremendous psychological impact,” the expert says.
“It costs more every 50 basis points and there’s no denying that, psychologically, it’s a big problem. Many entrepreneurs have never seen double-digit growth,” Rohit Arora, The co-founder and CEO of small business lender Biz2Credit agrees. “Psychology matters as much as fact and this could be a tipping point. A couple of people have brought double digits to my attention over the past few weeks.”
but It’s not only to come, but to keep, Beyond the psychological threshold of interest rates above 10%, the expectation is that the Fed will keep rates high for an extended period. Even with a view to slowing rate hikes and potentially stopping them as early as next year, there is no indication the Fed will cut rates even if the economy slips into recession. The loss will continue.
This problem is compounded by the fact that, as the economy slows (likely recession), will increase the need to borrow for entrepreneurs who are facing declining sales and are unlikely to receive additional aid from the Fed or the federal government.
Arora points out that reducing inflation from 9% to 7% will certainly be easier than reducing it from 7% to 4% or even 3%, wanting to show that the Fed isn’t going to loosen up any time soon. “It will take longer and it will be more painful for everyone,” he says. And if rates don’t come down until late 2023 or 2024, it could mean “a full year of higher payments and lower growth, and even if inflation does come down, it won’t do so at the rate it expects.” offset other costs,” he added.
‘Cocktail’ recession and higher rates
As recently noted by economist and former Treasury Secretary Larry SummersWith high interest rates and inflation, the economy could enter the first recession in four decades. “A longer-term problem awaits us,” says Arora. “This recession won’t be as deep as 2008, but we won’t see a V-shaped recovery either. The exit will be slow. The problem now is the rate.” There is no growth, the biggest challenge will be to stay at these levels for a long time.”
loss margin They have already been hit by rising monthly payment costs, and this means more business owners will be cutting back on business investment and expansion plans. “Talking to small business owners looking for funding, things are slowing down,” confirms Hearn.
However, the debt coverage ratio — the level of cash flow needed to meet monthly interest payments — has red flags. credit profile The number of entrepreneurs has not weakened overall, but banks will continue to tighten lending standards next year. Small business loan approval rates at large banks fell in November to the second lowest total in 2022 (14.6%), according to the latest Biz2Credit Small Business Lending Index released this week; And they also fell in smaller banks (21.1%).
“This is the desired effect for the Federal Reserve, but at the expense of the economy and at the expense of these smaller companies that are not well capitalized,” Hearn summarized. “So we have to contain inflation, and if it’s not already painful enough, it’s going to be even more so,” he concluded.