Digital Zeitgeist – Rate Rises Pile Pain On SME firms In U.S. and Europe
LONDON, March 30 (Reuters) – U.S. and European small and medium-sized (SME) firms may be next to feel the pain of rapid interest rate rises, with analysts and investors warily watching for the impact of tighter credit conditions exacerbated by recent banking turmoil.
Contrary to large corporations, which generally issue fixed-rate debt and experience minimal impact from short-term rate fluctuations, small and medium-sized enterprises (SMEs) depend on direct bank funding, causing them to feel the effects immediately. Although the vulnerability of SMEs to increased rates and potential defaults has largely remained unnoticed by investors, particularly as larger businesses have fared well, some are now monitoring for signs of stress.”
As liquidity drains, what seems like idiosyncratic little issues start to pop up,” said Brett Lewthwaite, global head of fixed income at Macquarie Asset Management.
S&P, the ratings agency, anticipates that U.S. and European default rates will reach 3.75% and 3.25% by September, more than doubling the 1.6% and 1.4% rates from the same month last year. SMEs play a vital role in both European and American economies. The European Commission estimates that SMEs employ approximately 100 million people in the EU, contributing to over half of the bloc’s economic output.
The European Central Bank’s most recent Bank Lending Survey reveals that Eurozone banks reported a significant tightening of credit standards for loans or credit lines to businesses in the fourth quarter of 2022, prior to this month’s bank stress. This marked the largest shift recorded by the survey since the bloc’s 2011 debt crisis. The European Banking Authority (EBA) was not immediately available for comment.
In the US, the average rate that small businesses pay on bank loans increased from around 5% to 7.6% in 2022, and Jefferies analysts predict it will likely reach approximately 9.5% by mid-year. Analysts also highlight that the latest US Senior Loan Officer survey indicates “significantly tighter” credit conditions for SMEs.
Unlike large corporations that typically issue fixed-rate debt and are less affected by short-term rate fluctuations, SMEs depend on direct bank funding, making them more susceptible to immediate impacts. While SMEs’ vulnerability to higher rates and potential defaults has largely remained under investors’ radar, especially as larger companies have fared well, some are now watching for signs of distress.
In the current deteriorating environment, big is beautiful and smaller companies are going to feel the most pressure from interest and energy costs, broken supply chains and a lower real disposable income from households,” said Generali Investments’ senior credit strategist Elisa Belgacem.
DISTRESS RISES
The iTraxx Europe Crossover index, measuring the cost of insuring exposure to a basket of junk-rated corporate bonds, has risen recently but is well below peaks seen during the COVID crisis.
Guy Miller, the chief market strategist at Zurich Insurance Group, said that even with sharp rate rises, investor focus has been on companies that are in good shape and well-positioned to handle higher borrowing costs.
“But when you think of all the smaller and medium-sized companies in Europe and U.S. that are dependent on bank financing, revolvers (a type of bank facility), and often even on owner financing, funding is becoming a major issue,” he said.
British SMEs, hurt by weak growth, double-digit inflation, and rising Bank of England rates, are seen as particularly vulnerable.
UK corporate distress levels accelerated in the quarter to February to their highest since June 2020, an index compiled by law firm Weil Gotshal & Manges shows.
Another recent survey by Manx Financial Group showed that 22% of UK SMEs that needed external finance over the last two years were unable to get access due to the higher cost of funding, processing times, and lack of flexibility.
Manx Financial Group CEO Douglas Grant said while many SMEs had locked in rates for a fixed period, to limit exposure to further rate increases, others had not.
“Small businesses are counting on today’s rise in the base rate to be the peak, as the Bank of England predicts a steeper than anticipated fall in inflation, even following the unexpected rise we saw earlier this week.
In response to the most recent BoE rate increase, Federation of Small Businesses (FSB) National Chair Martin McTague said, “inflation is exacting huge tolls on small firms, who are even more exposed to spiralling input costs than large businesses”.
“The Government needs to demonstrate that it is on the side of small businesses who are feeling stressed and under huge margin pressure,” McTague added.
HARD TIMES
Meanwhile, the rate of small business loan approval at big U.S. banks meanwhile fell in February for nine straight months and business loan approvals at small banks have also fallen, said online financing platform for small businesses Biz2Credit.
Small U.S. banks have seen a $119 billion exodus in recent weeks as depositors took fright after the collapse of Silicon Valley Bank.
Biz2Credit CEO Rohit Arora said he expects it will now become even harder for small businesses to secure capital, with the biggest challenge that rates stay higher for some time.
“While it’s unlikely that rates will come down before next year, at least business owners will know this is the maximum they have to pay,” Arora said.
Nevertheless, as financing costs jump and become harder to access, the risk of a spike in default rates is becoming increasingly tangible, analysts said.
“The weak hands are starting to be revealed,” said Macquarie’s Lewthwaite.
online sources: reuters.com. zurich.com, fsb.org.uk, mfg.im, macquarie.com