Community banks are becoming increasingly wary of business loans. Inflation is lowering small and medium enterprises' performance, making them unable to meet their financial obligations, including repaying loans. As a result, many community banks are closing open lines of credit for small businesses to avoid incurring losses. Many banks are also selling low-quality business loans, while some are selling off entire lines.
Community banks' decision to sell off small business loans is not surprising, and may be justified considering the economy's performance. Here is a comprehensive overview of why community banks are becoming increasingly worried about small business loans.
Many banks have been pessimistic about the economy's future during and after the COVID-19 pandemic. A January survey showed that 20% of bank executives managing at least $10 billion in assets expected the economy to worsen moderately or significantly in 2022. This number rose to 47% in a follow-up survey in April.
Banks have also been scaling back their small business credit lines since the onset of the COVID-19 pandemic. A study by Biz2Credit shows that community banks approved about 50% of all small business loan applications in 2020. In contrast, they approved only 20.5% of applications in February 2022.
The United States is reeling from runaway inflation, which recently surpassed 8%. 2022 set the record for the highest month-over-month inflation rate increase, over a six-month period, since 1982.
Many bank managers and economists were also rightly worried about the U.S. economy going into recession because of the runaway inflation. The inflation and recession have affected small businesses – which need healthy cash flows to remain operational – disproportionately.
Some of the most notable impacts of inflation on small businesses include:
Inflation is increasing the cost of doing business for most small businesses. A survey by Business.org shows that 92% of small businesses are spending more on supply and operating costs since the onset of the COVID-19 pandemic. The supply chain crisis is partly to blame for this, as some of its most notable impacts on businesses' operations include:
Inflation has only made things worse, as the survey shows that 71% of small businesses experienced a 20% increase in their operating costs. About 16% saw their costs increase by as much as 50%.
Small business owners have been exploring various ways to deal with the rising supply and operating costs. Ultimately, about 89% have had to raise their prices to offset the higher costs and maintain healthy profit margins.
According to the survey by Business.org, about 44% raised their prices by 15%, while 45% raised theirs by more than 20%. Approximately 11% of businesses – presumably those that didn't experience increases in their operating costs – didn't raise prices.
Many of the businesses that have raised prices are concerned about the move's impact on customer experience. Expectedly, customers tend to buy less when prices rise, making it a compromise for both parties – small businesses still have to contend with narrower profit margins.
The survey also reports that about 50% of all small businesses are reducing their inventory because of the financial and operational constraints caused by the ongoing inflation and the pandemic's after-effects. Many small businesses have also been taking other measures to lower their operating costs and maintain healthy financial flows, including:
These changes have limited businesses' operations and reduced their revenues and profits. Only 17% of small businesses have not made any changes to reduce their operating costs.
Unfortunately for small businesses, inflation may persist for longer than desired. Many economists predict that inflation will start easing towards the end of 2023, meaning that businesses have to contend with their cash flow problems for at least one more year. Recovery may also be slow and inconsistent after inflation goes down.
Community banks are aware that many of their small business borrowers may not be able to repay their loans because of the ongoing inflation and economic uncertainty. Many are responding by selling off low-quality loans, and some are selling off entire lines of business credit.
Michael Anderson, an analyst at Citigroup Inc., says that the average discount on loans sold in the recent past is the highest in a decade, explaining the rush by community banks to sell off small business loans. However, loan prices will decrease soon as the markets either slow down or seize up. Banks still holding onto their loans by then will have to sell them off at lower costs or contend with the risk of defaults.
Inflation, the pandemic's after-effects, and the economy's inconsistent outlook all paint a bleak future for small businesses. Many small businesses are already struggling with cash flow problems, and many are taking drastic measures to stay operational. Unfortunately, many small businesses may not be able to repay their loans if the economy doesn't improve.
Fortunately, community banks with small business borrowers can cut their losses by selling their low-quality loans. Garnet Capital Advisors specializes in representing banks selling their loans, and we have solutions to ensure compliance with complex regulations. Get in touch today to learn more about selling or buying a small business loan.