High US interest rates add to headwinds for small businesses
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[December 19, 2023] By
Timothy Aeppel
(Reuters) - After Ron Hall took out a $407,000 Small Business
Administration loan last year to open a franchised sandwich shop in his
hometown in Tennessee, business boomed.
He hired 15 employees and even snapped up a used Honda CR-V that he
covered in his store's logos to sell sandwiches in the parking lots of
local factories during lunch hours. Early on, the 49-year-old father of
two said he was seeing $3,000 a day in total sales.
But monthly payments on his SBA loan, which carried a 7% interest rate
in May 2022, snowballed by almost $1,000 a month to $6,000 as the rate
rose to more than 11% over the past year, in step with aggressive
Federal Reserve rate hikes to tame high inflation.
Other financial pressures bore down. The price of lettuce and french
fries surged, he said, and his mostly working-class clientele,
struggling with higher grocery and fuel prices, cut back on eating out.
Daily sales now seldom exceed $1,100 and Hall has cut his workforce to
seven.
"It feels like everything went sideways," he said.
That sentiment seems to be shared by many U.S. small businesses. A
recent survey of its members by the 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 back SBA loans or securing new ones from the government
agency has become much harder.
Higher rates add to other headwinds. The effects of the inflationary
surge hampered most businesses, regardless of size. Smaller companies,
however, are more vulnerable because they often lack the leverage of
bigger firms to pass along higher costs to consumers.
VULNERABILITIES
The good news is that inflation has been slowing, which should
eventually bring relief on borrowing costs. The Fed held interest rates
steady at the end of a policy meeting last week, with officials flagging
plans to start gradually cutting borrowing costs in 2024. The U.S.
central bank's actions have boosted optimism about a "soft landing" in
which inflation continues to slope down to the Fed's 2% target without a
sharp rise in unemployment or a contraction in economic activity.
"The economy has been doing reasonably well - so many of these small
businesses are still cash-flow positive," said Thomas Simons, senior
U.S. economist at Jefferies. "But the environment overall isn't really
conducive to expansion or hiring."
Simons said conditions were ripe for small startups in 2020 and 2021,
with interest rates low and a surge of demand for some goods as the
COVID-19 pandemic struck. "Now, with rates much higher, that doesn't
seem to be the case," he said.
The SBA said loan defaults, after falling sharply as a result of
pandemic relief programs, are rising but are still lower than they were
before the start of the pandemic.
There is no evidence yet that smaller employers are cutting lots of
jobs, Simons added, although for some time he has been flagging small
businesses with floating-rate SBA loans as increasingly vulnerable on
that front. According to the U.S. Department of Labor, U.S. job growth
accelerated last month, and the unemployment rate fell two-tenths of a
percentage point to 3.7% - signs of underlying labor market strength.
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A worker with a face shield checks products on the shelf of a
grocery store in the Manhattan borough of New York City, New York,
U.S., August 7, 2020. REUTERS/Carlo Allegri/File Photo
The surge in interest rates, meanwhile, hasn't prompted a rash of
bankruptcies. Data compiled by the American Bankruptcy Institute (ABI)
on the type of bankruptcies declared by small companies shows these
filings have edged up over the past year, said Soneet Kapila, ABI's
current president, "but the main cause may be a combination of
general economic pressure from poor business performance," not
interest rate pressures.
There are signs cost pressures are limiting growth. The same survey
of small businesses by Alignable that found companies felt burned by
higher interest rates also showed constraints on hiring, with 58% of
respondents saying they couldn't afford to hire the employees they
need. That's up 14 percentage points from October, and is 8
percentage points higher than in September.
TAKING A GAMBLE
J.B. Brown, the CEO of BCI Solutions, a metal foundry in Bremen,
Indiana, watched his business surge during the pandemic. But demand
has cooled in the past year.
Although Brown still needs to add workers with advanced technical
skills, he has enough basic production workers to meet the softened
demand. The challenge is mounting costs. He estimates wages are up
35% compared to before the pandemic, and the cost of his property
and liability insurance policy just doubled.
Still, he's gambling on the future: In an uncharacteristic move for
a conservative family-owned business, Brown just took out a $7
million bank loan to buy a new machine.
"We've pulled out of improvements and expansions in the past because
it seems like whenever you're getting ready to do it, the economy
tanks," he said. "But then we always look back and say: 'We
should've done it anyway.'" The new machine, however, will produce
twice the output of the two older machines it is replacing while
requiring half the number of workers to operate, he noted.
Brown's decision cuts against the larger trend. This type of fixed
business investment has been weak in recent quarters, putting a drag
on otherwise strong GDP growth. Fed Chair Jerome Powell noted last
week that high interest rates have curbed this type of spending.
Brown said higher rates are a challenge but added that "it's time to
invest."
Hall, the owner of the sandwich shop in Harrogate, Tennessee, has a
gloomier view. He just managed to get his bank to issue a home
equity loan that will replace his SBA loan with an interest rate
closer to his original 7%.
He once dreamed of opening a second shop but has dropped that idea,
and now regrets getting into the business at all.
"If I could find a way to sell it, I would do it in a heartbeat," he
said.
(Reporting by Timothy Aeppel; Editing by Paul Simao)
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