Analysis – High US interest rates add to headwinds for small businesses According to Reuters


© Reuters. FILE PHOTO: Shoppers make their way through Pentagon City’s Fashion Center, decorated for the holidays, in Arlington, Virginia, U.S. December 23, 2019. REUTERS/Jonathan Ernst/File Photo

By Timothy Aeppel

(Reuters) – After Ron Hall took out a $407,000 loan from the Small Business Administration last year to open a franchise sandwich shop in his Tennessee hometown, business boomed.

He hired 15 employees and even collected used ones Honda (NYSE: ) CR-V, which he covered up his store logos to sell sandwiches at lunchtime in the parking lots of local factories. Soon after, the 49-year-old father of two said he was making $3,000 a day in total sales.

But monthly payments on his SBA loan, which had a 7% interest rate in May 2022, snowballed by nearly $1,000 a month to $6,000 as the rate rose to more than 11% over the past year, in line with aggressive rate hikes Federal Reserve System. tame high inflation.

Other financial pressures have subsided. He said the price of lettuce and chips had soared and his mostly working-class clientele, struggling with higher food and fuel prices, had cut back on eating out. Daily sales now rarely exceed $1,100, and Hall has reduced his staff to seven.

“I feel like everything is falling apart,” he said.

This sentiment seems to be shared by many American small businesses. A recent survey of members of small business networking group Alignable found that 58% said they were being hurt by high interest rates — up from 45% who said so in June. In a follow-up question, 24% said paying off SBA loans or securing new loans from a government agency is much more difficult.

Higher rates add further headwinds. The effects of inflationary growth have hampered most businesses regardless of size. However, smaller companies are more vulnerable because they often lack the leverage of larger firms to pass on higher costs to consumers.

VULNERABILITY

The good news is that inflation is slowing, which should eventually bring relief to borrowing costs. The Fed kept interest rates steady at the end of last week’s policy meeting, with officials announcing plans to gradually cut borrowing costs through 2024. The U.S. central bank’s moves boosted optimism about a “soft landing” where inflation continues to fall. to the Fed’s 2% target without a spike in unemployment or a drop in economic activity.

“The economy is doing fairly well — so many of these small businesses are still cash-flow positive,” said Thomas Simons, senior U.S. economist at Jefferies. “But the environment as a whole is not really conducive to expansion or hiring.”

Simons said conditions were ripe for small startups in 2020 and 2021, with interest rates low and demand for some goods surging as the COVID-19 pandemic hit. “Now, with much higher rates, that doesn’t seem to be the case,” he said.

The SBA said loan defaults are rising after a sharp decline due to pandemic relief programs, but are still below pre-pandemic levels.

So far, there is no evidence that smaller employers are shedding a lot of jobs, Simons added, although he has for some time characterized small businesses with floating-rate SBA loans as increasingly vulnerable in this area. According to the US Labor Department, US job growth accelerated last month and the unemployment rate fell by two-tenths of a percentage point to 3.7% – signs of underlying strength in the labor market.

Meanwhile, the rise in interest rates did not trigger a flood of bankruptcies. Data compiled by the American Bankruptcy Institute (ABI) on the types of bankruptcies filed by small companies show that the number of such filings has increased slightly over the past year, said Soneet Kapila, the ABI’s current president, “but the main cause may be a combination of general economic pressures from poor business performance.” not interest rate pressures.

There are indications that price pressures are limiting growth. The same survey of small businesses by Alignable that found companies feeling burned by higher interest rates also showed hiring constraints, with 58% of respondents saying they can’t afford to hire the staff they need. This is 14 percentage points more than in October and 8 percentage points more than in September.

PLAY THROWS

JB Brown, CEO of BCI Solutions, a metal foundry in Bremen, Indiana, has watched his business grow during the pandemic. But demand has cooled in the last year.

Although Brown still needs to add workers with advanced technical skills, it has enough basic production workers to meet the softening demand. The challenge is rising costs. He estimates wages are up 35% compared to pre-pandemic, and the cost of his property and liability insurance has just doubled.

Still, he’s betting on the future: In an uncharacteristic move for the conservative family business, Brown just took out a $7 million bank loan to buy a new machine.

“In the past, we’ve given up on improvements and expansions because it seems like whenever you’re going to do that, the economy tanks,” he said. “But then we always look back and say, ‘We should have done it anyway’.” However, the new machine will produce twice the output of the two older machines it replaces, while requiring half the number of workers to operate. he remarked.

Brown’s decision bucks a larger trend. This type of fixed business investment has been weak in recent quarters, holding back otherwise strong GDP growth. Fed chief Jerome Powell noted last week that high interest rates have limited this type of spending.

Brown said higher rates were a challenge, but added that “it’s time to invest.”

Hall, the owner of a sandwich shop in Harrogate, Tenn., takes a gloomier view. He just managed to get his bank to issue a home equity loan to replace his SBA loan with an interest rate closer to his original 7%.

He once dreamed of opening a second store, but abandoned the idea and now regrets ever getting into the business.

“If I could find a way to sell it, I would do it now,” he said.