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.

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11 comments

  1. Sandwichman

    So, September and October, eh? That’s right before the election. Presumably there were provisions for extending the SBA guarantees in the unemployment benefits extension bill and the Republicans vetoed it with hardly a whimper from the Obama administration. What’s the Democratic party campaign slogan going to be? “We wanted to do something but those mean old Republicans wouldn’t let us”?

  2. JuddBudd

    Come on, Yves… who needs small businesses? This is about consolidation of the “Too Bigs” of Wall Street: save the mega-corporations at the expense of everybody else…. If we don’t have Goldman, GM, et. al. where would America be…?

  3. Jackrabbit

    Funding for entrepreneurs is even worse.

    1) At the high end, the Venture Capital Market virtually shut down for a while because the IPO market was dead. It has not recovered much.

    2) Potential sources of capital for new initiatives, such as yourself (savings), or friends and family, are more risk adverse than ever.

    3) Government Stimulus was largely directed at big business or established “small business” (50-500 people). There was virtually no benefit to startups.

    Government talks a lot about innovative entrepreneurial-ism but it seems to me that that is mostly lip service designed to prompt potential entrepreneurs (the recently unemployed) to spend money and get them off the unemployment rolls. Generally what is available are tax breaks for new manufacturing and tech businesses but there is a high hurdle (a lot of money spent) before a business benefits from such tax breaks.

    And, despite the CRE bust, office space remains expensive for a startup. And rents at new business “incubators” are not really much cheaper than market rents – they just allow you to pay month to month instead of committing to a lease.

    So serious entrepreneurial-ism (not just opening a franchise) is for people with strong skills and knowledge (who probably wouldn’t have much trouble finding a good job) with time on their hands that have a substantial amount of money. The vast majority such people do not want to spend 10 hours a day 7 days a week trying to make a startup work. And the government doesn’t want to support less well off folks who have the entrepreneurial drive.

    1. Tom Crowl

      It’s also a point worth mentioning that entrepreneurs obviously don’t get any unemployment benefits…

      Not that they’re expected… however it does make things more difficult.

  4. Bruce

    I don’t think 3.5% – 4% is very high. Maybe the businneses that can borrow at that rate don’t see enough new business to justify additional borrowing.

  5. The humanity

    Perhaps the Lords of Finance and Corporate have decided to consolidate their power. They no longer require the fiction of a “Free” market to hold the Serfs in thrall – they have all the Tools they need to confuse, coerce and control without having to deal with those pesky small business types, with their outmoded notions of fair and honest competition.

    See you on the Plantation

  6. Ronald

    Small business as the engine of employment only works if the demand side (consumers) have lots of cheap available credit and small business today reflects that reality with slack demand. The other issue is volume by that I mean margins in business today are small so high volume rather then custom manufactured or hand made so to speak is becoming the standard which requires automation and distribution capabilities all very expensive from a start up point of view and beyond what a person can borrow on their card or house.

  7. Rahul

    Most small businesses tend to be in Retail, Construction, Home Improvement, Staffing, Brokering (Read people on commission), Commercial real estate etc. which are the worst effected in a Credit Bust. The lack of lending represents the lack of creditworthy customers in these areas more so than a willingness to lend. These are the types of businesses that grew during the housing/lending bubbles and are now going out of business at a record pace. This seems to me a natural consequence of the bust and the government attempts to fight this is actually throwing good money after bad because these businesses will go bust anyway and the government effert to lend to them will only cause bigger losses.

    1. Jake

      This fact about the nature of small business is important to consider whenever one hears the claim that small businesses created the bulk of new jobs over the last decade. According to the SBA, employment at small businesses (i.e., firms with fewer than 500 employees) as a share of total payroll employment fell from about 55% to about 50% from 1988 to 2006 (later figures are not available). This is in conformity with the long-term trend in the industrial and post-industrial West. What we are seeing with the current small business shake-out is simply the end of a brief historical abberation and the return to the long-term trend.

      In my mind, we as Americans do ourselves a great disservice shedding tears over the fate of small business. It is simply illogical to pin our hopes for economic rebound on firms that do not realize economies of scale.

      1. NOTaREALmerican

        Sadly, that’s true.

        Bigness is the only thing that matters now. Government gets bigger, corporations get bigger, my Zombie bank gets bigger. Only when everything is 2Big2Fail will we be safe from – uh, well – failure.

  8. Start-up

    I’ve just applied for only $180,000 to start-up a new business over the last month, I’m putting in $50K, their loans are backed by the governement 75% or 90% and they still say no. They say no by saying your income level needs to be higher and we really only look at companies that have been open for two years or longer. What??? By definition it’s a START-UP. What does it take besides money to get ahead in this crapy country? Believe me I’ve put in the hard work so the baby boomers can live high life.

    Jake maybe you should tell baby boomer friends to stop spending our money on small businesses they nothing about and let the people that do know have a fair shake. Maybe then you’ll see the increases in job growth like before the baby boomers ruined it for everyone.

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