When Banks Tighten Their Belt, Small Businesses Feel the Squeeze.

According to the NerdWallet Small-Business Finance index, the slowdown in small business financing-related activity has been exacerbated by rising interest rates and uncertain economic conditions. This is corroborated by a recent Federal Reserve survey that shows how the pandemic affected the small business sector's financial situation. Financial issues affected 85% of small businesses in 2021, up almost 20% from 2019.

Even in normal times, it can be difficult for a smaller business to receive loans from traditional banks because they lack the assets or credit records of larger companies. This is true even while inflation is at its highest level in decades and workers are demanding higher wages. Also, most business owners lack an understanding of the factors that guide lending decisions made by banks and other lenders.

Delayed Financial Documents

We are helping multiple clients who are several years behind on their taxes. In many cases, their financial statements are lagging as well. And yet, despite not having the financial information necessary for banks to make a sound credit decision, these businesses continue to seek working capital to operate. This disparity plays a major part in the low success rate for companies seeking debt financing from their local bank or lender.

In contrast to approximately half in 2019, just about 30% of businesses that applied for financing last year were granted the full loan amount. Moreover, the National Small Business Association's president warned that the present credit climate could make it more difficult for smaller businesses to recover from the pandemic. Their balance sheets, which lenders use to evaluate loan applications, were diminished during the pandemic, even if their projected sales look promising.

Compared to 28.3% in February 2020, big banks only approved 14.7% of loan requests in February 2021. Moreover, 20.5% of loan requests were approved by small banks, down from 50.3% in the same month in 2020. That's according to the data of 1,000 small businesses that applied for funding on the online lender, Biz2Credit's platform. 

Alternative Financing

Due to the stinginess of the bigger banks, small businesses are now looking at alternatives including community banks, asset-based lenders (ABLs), and online lenders. Alternative financing may be easier to obtain, but it may have higher interest rates or harsher penalties. Small business loans from traditional banks often have interest rates of up to 7%, however, loan rates from alternative lenders can easily be 10% or more. 

As the current economic cycle progresses, credit availability is only going to get tighter. Rising interest rates could make it more difficult for small businesses that need funding because a lot of business loans are short-term in nature and often involves fluctuating interest rates.

In today’s environment of economic uncertainty, getting credit is likely going to be more expensive. Underwriting guidelines will almost certainly get tougher as delinquencies and defaults increase the bank’s risk of taking a loss. Tightening lending guidelines is their natural response to mitigate this risk.

Finding the Best Fit

In the coming months, small business financing will probably cost more due to a more restrictive lending climate, but knowledgeable business lending advisors like Lionsford are aware of steps businesses can take now to ensure they get the best terms possible.

To increase their approval odds in today's credit market, business owners should make sure their financial statements and tax returns are complete, correct, and current. Additionally, they must be prepared to explain each line item and the story behind it, should something come into question from the underwriter. It is also important that they can communicate to the lender how the information on the tax returns ties to the information on the financial statements. 

If a business owner lacks industry contacts or expertise, they should not be afraid to reach out to a business lending advisor like Lionsford before pursuing a loan. While a "yes" can occasionally become a "no", rarely does the reverse hold true.  Businesses that are in need of financing are encouraged to apply.  Our team will provide multiple quotes within 24 hours, and it won't affect their credit score.