Small Businesses Cope With An Historically Challenging Lending Environment

News/01/11/2023

Small businesses are facing the toughest lending environment in decades as the recent Fed-initiated rate hike ripples through the economy. Over the previous 9 months, interest rates have risen by 4.25%. It is easy to forget that interest rates were at historic lows at the beginning of the year. For the first time since 2008, small business loans have cracked the 10%-plus interest rate threshold, making loans too expensive for many, as well as psychologically daunting. With inflation rates still too high, many small business owners are looking to cut expenses related to staffing, and downward consumer sentiment is adjusting revenue forecasts. Mid-December’s seventh interest rate hike of .5% will likely not be the last as most observers expect continued Central Bank incremental upticks into the new year. Higher interest rates will impact all types of borrowing including credit cards and mortgages.

For many, government small-business loans are the go-to for financing, but it may make better sense over the next 12 to 24 months to examine alternative funding sources. A fixed-rate, short-term bridge loan will offer flexible terms and a more advantageous loan structure that can impact monthly payments. Avatar Financial Group’s founders, CEO Jerry Zevenbergen, and President, T.R. Hazelrigg, IV, explain how a bridge loan can provide liquidity to maintain cash flow for operations while protecting against incoming rate hikes and daily prime rate fluctuations.

Zevenbergen explains, “Considering the cost of time, arduous effort, and prepayment penalties a borrower may incur when refinancing a high-rate SBA loan—a bridge loan may be a better bet. A bridge loan may have a slightly costlier rate but may be lower on a current pay basis since there is no principal amortization. In addition, when rates decline, you can typically pay it off without incurring additional fees.”

Hazelrigg agrees, “That’s a great point to consider. A small business owner taking out a conventional or agency loan at today’s interest rates will end up managing similar costs with less flexibility than a bridge loan. Bridge loans are less cumbersome, only slightly more expensive, and provide maximum flexibility to finance when rates drop.”

According to Neil Bradley, Executive Vice President and Chief Policy Officer of the U.S. Chamber of Commerce, small businesses are extremely sensitive to interest rate changes. Nearly half of the small business owners surveyed share that inflation is their top issue, a stark 31-point increase since this time last year. Its most recent Q3 2022 Small Business Index reports, “Small businesses are now less confident in both the U.S. economy and their local economic environment and are less comfortable with their current cash flow.” As the Fed raises the prime rate, interest rates will continue to rise and conversely, funds will be less readily available as marketplace liquidity is constricted.

Hazelrigg illustrates a considerable benefit of a bridge loan versus conventional financing, "Business owners should weigh carefully, the cost of precious time, especially in a constrained economy. It is common to wait months for approval for a conventional loan, and as we slog through this period, banks are becoming more stringent and less willing to lend.” Avatar’s bridge loan approval process is much faster, typically within a few weeks. We will evaluate the quality of the commercial real estate asset being offered as collateral and consider other “common sense” underwriting criteria. Contingent upon our findings, it may be possible to extend a loan based on the property’s loan-to-value (LTV) at a competitive fixed rate for a short term, ranging from 12-24 months.

The SBA’s most common loan programs are 7(a) (which can be used for a wide range of purposes), and its 504 loan program (limited to purchases of fixed assets and real estate). A lender providing an SBA loan most commonly calculates an interest rate using the prime rate as its fixed base rate, which is currently 7.5%, plus an allowable spread of 3%. The fixed rate is the same for all loans and does vary per month based on interest rate fluctuations. These loans are amortized with scheduled, periodic payments that are applied to both the loan's principal amount and the interest accrued. Pre-payment penalties apply when refinancing early, and the underwriting process weighs personal eligibility and other special considerations.

Current SBA Lending Interest Rates

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Source: SBALenders.com

Bridge loans are structured differently from amortized lending instruments. A sponsor pays interest only for the term of the loan. Zevenbergen explains. “Avatar’s bridge loan is more straightforward and flexible than a conventional amortized loan. The borrower’s monthly payment is going to be about the same because you are not making payments on the loan principal and interest.”

Hazelrigg adds, "A bridge loan will be free of major pre-payment penalties allowing borrowers to refinance conventionally when timing and market conditions are right. This agility can mean a lot to a business that may need fast access to liquidity locked in their commercial real estate to meet payroll obligations or purchase inventory. Being able to access needed capital quickly may be the difference between staying in business through tough times or closing up shop, a decision no small business entrepreneur wants to face in the coming year.”

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