“The combination of further Fed actions increasing rates and credit tightening that is happening in some sectors could have a detrimental effect on the economy and small business,” said Carlos Naudon, CEO of Ponce Bank in New York City, which makes loans mostly in the $10 million to $50 million range, often to real estate companies.”
Bloomberg
The failure of Silicon Valley Bank on March 10 sent small businesses across the country scrambling to ensure the safety of their money.
It’s a painful memory: In 2009 the banking crisis and housing recession led to a credit crunch, and business owners suddenly couldn’t access the capital they needed to operate and grow.
The latest banking crisis so far bears little resemblance to the one that kicked off the Great Recession. Crain’s reporters in New York, Michigan, Illinois and Ohio set out to understand how the dynamics between small businesses and their bankers are playing out in the weeks following the banking crisis sparked by the failure of Silicon Valley Bank and Signature Bank. We discovered much concern but little tangible evidence of a credit crunch just yet. In fact, lending has increased since the failures.
But there are signs of worry as small and midsize businesses shore up finances ahead of a potential recession and banks reassess their balance sheets. In West Michigan, community banks say they are doing more diligence on every loan application. In New York City, one accountant’s clients are turning to credit cards as a short-term solution when loans are expensive or slow to close. In Chicago, retail real estate brokers are banking on longer lead times from their clients opening up new stores and restaurants in the event credit applications take longer. In Oak Park, outside Chicago, a mobile-spa owner has turned to community banks and his credit card processor for funding, noting that the amount of capital available is shrinking.
S&P puts debt for Vornado, Boston Properties on watch for downgrade
“I don’t know of anybody that’s directly said, ‘Our loan got killed. We were in the approval process and they killed it.’ I think that’s coming,” said Chris Irwin, senior vice president of retail sales at the real estate brokerage Colliers in the greater Chicago area. “[The banks] are going to get conservative and they’re just going to pause.”
The rumblings ahead of the latest crisis began last year when the Federal Reserve started increasing the federal funds rate in an attempt to combat inflation. Things came to a head in early March, when depositors of Silicon Valley Bank and Signature Bank discovered that their banks had unsustainable balance sheets. SVB would have had to sell long-term bonds at a big loss to meet depositors’ requests for liquidity. Within days, the Federal Deposit Insurance Corp. stepped in to backstop the banks; depositors at the failed banks and at similar regional banks will be made whole while shareholders are wiped out.
Lending actually increased in the weeks following those events, according to the most recent data from the Federal Reserve Bank of St. Louis, which tracks business credit. Between the weeks of March 8 and March 15, lending among all commercial U.S. banks expanded from $17.5 trillion to a record $17.6 trillion. Smaller banks saw more deposits than larger ones the week ending March 22, according to Federal Reserve data.
Below the surface, bankers and business owners are grappling with the potential for more regulation on small banks, the question of how much interest rates will go up, and a wholesale rethinking of the nature of banking relationships.
“The combination of further Fed actions increasing rates and credit tightening that is happening in some sectors could have a detrimental effect on the economy and small business,” said Carlos Naudon, CEO of Ponce Bank in New York City, which makes loans mostly in the $10 million to $50 million range, often to real estate companies.
That is also the point of the Fed’s efforts: Credit tightening is one of the desired effects of inflation-fighting monetary policy. If tightening does occur, “that means that monetary policy may have less work to do,” Federal Reserve Chair Jerome Powell explained at a late March news Conference. If credit doesn’t tighten, he implied, the Fed might have to keep raising interest rates.
The upshot: Any business with a loan renewing soon should try to get favorable terms soon, advised Mike Tierney, president and CEO of the Community Bankers Association of Michigan.
Expensive money
P.J. Harris, who runs Spa In Your Space, a mobile-spa business in the Chicago suburb of Oak Park, wants to borrow $30,000 to invest in new equipment and advertisements. Harris works with his wife and is a subprime borrower. He has a line of credit from a community-based group, rather than a traditional bank. He also looks for loans from alternative providers, such as his credit-card processor Square.
“There’s money out there,” he said. “It’s hard to get, but it’s doable.”The 20-year-old company, which primarily serves businesses and corporate events, has been bouncing back from the pandemic in part by seeking financing. Terms have changed recently, though.“ They’re not as generous as they were before Covid,” he said of the loan offers from Square and others.
Courtesy of Spa In Your Space Instagram
Mobile spa business Spa In Your Space, which brings relaxation directly to companies in the Chicago area, has turned to alternative credit providers for funding in the wake of the banking crisis.
Businesses need money to grow, and it’s not new that not all of them can land the dollars they seek at the price they prefer. The federal funds rate—the rate at which banks borrow from the Federal Reserve—has gone from near zero percent at the beginning of 2022 to 4.6% in February of this year. Rates for customers tend to be higher.
As an example, interest on a 10-year Small Business Administration 504 loan, available to companies with an average net income of less than $5 million that plan to use the money for growth, was 6.78% on March 30, nearly double the 3.82% rate from a year ago.
“Everything has gotten more expensive,” said Ted Macke, an accountant at Fingerman & Macke who works with small and medium-size businesses in the New York City metropolitan area. “Loans subject to variable interest rates are getting killed and new loans have higher rates, so it’s harder to qualify.”
Capital is even more expensive for companies that cannot get loans. For companies that end up in need of cash for unexpected expenses or working capital, the last-ditch options aren’t great. “A lot of businesses are using credit cards for cash flow,” Macke said. “They even carry balances.”
An increasing number have turned to merchant cash advances, which provide money upfront to less-qualified borrowers but at terms that translate to triple-digit interest rates.
Even New York state is feeling the pinch. The governor’s office said the state would pay cash toward its incentive deal to build a new Buffalo Bills stadium, thanks to the higher cost of issuing long-term bonds, The Buffalo News reported. The state needs to pay $182 million of its $600 million commitment this year. Leaders have issued long-term bonds in the past for similar large capital projects.
Close examination
Businesses say that their banks are doing extra diligence on loan applications.
“What you could do with a [credit score] of 650, now it’s 680,” said Jennipher Adkins, interim executive director at the Chatham Business Association, which coaches and assists business owners on the South Side of Chicago. The tightness has increased in line with rising interest rates in the past eight months, Adkins said.
“With 650, there are more fees. If there’s one 30-day, past-due [bill] in your file, they want a letter of explanation,” Adkins said. “They’re really scrutinizing more things. It’s very challenging. Credit cards aren’t going to help you. What people really need is a line of credit. The products just aren’t out there.”
That banks are scrutinizing their customers is hardly new.
“This is a structural problem that has existed for a long time,” said Daniel Marsh, president of the Brooklyn-based National Development Council, which provides affordable loans to small businesses across the country. “Over the years larger banks have changed their lending profile to do larger loans with customers with higher balances, higher revenue and more of a business relationship for that bank.”
Alamy
Companies that would normally be too large to work with Ponce Bank have come calling in the wake of the banking crisis, says Carlos Naudon, CEO of the New York City-based bank.
Companies that would normally be too large to work with Ponce Bank have come calling in the wake of the banking crisis, says Carlos Naudon, CEO of the New York City-based bank.
The reasons are different now. On the one hand, banks can earn relatively high interest rates on their own cash and may want to be clear about the risks of new loans. On the other hand, they may feel the pressure of duration risk—loans already on their books that are losing value. This was the source of SVB’s problems.
“A bank that has earnings pressure has capital pressure, and that will make them less likely to lend,” said Thomas Wells, CEO of First American Bank in Elk Grove Village.
There are also rumblings that more intense diligence could become a requirement, some experts say.
Currently, banks with more than $100 billion in total assets have stringent requirements about how much capital they keep on hand. So far, smaller banks are exempt.
It’s possible that the regulations could change. In the wake of the recent bank collapses, examiners could look to strengthen bank capital requirements to promote security in the financial system.
“That could be a concern,” said Michael Adelman, president and CEO of the Ohio Bankers League. “But it’s not something that we’re seeing today.”
Banks could make their own push to have more cash on hand, said Brian Calley, a former business banker who is now president and CEO of the Small Business Association of Michigan.
“I think, in the short term, this will result in banks being less aggressive in offering credit,” Calley said. “So [they will be] tightening up credit standards, maybe not doing bigger deals and [have] less appetite for new business.”
Changing relationships
The immediate lesson of the Silicon Valley Bank collapse: Don’t keep all your money in one place. As a result, some small companies are developing relationships with more than one banker, a possible upside for times when they need access to cash.
The “new standard” for companies will be to expand their banking relationships, agreed Chris Rizik, CEO and fund manager of Renaissance Venture Capital, an Ann Arbor, Michigan-based fund of funds that invests in other venture capital funds as opposed to directly into startups.
Gone will be the days of a company putting all of its $10 million capital raise into one bank, Rizik said.
“We’re going to see that startup companies are going to have two banking relationships, and the lion’s share of big fundraises will go into larger banking relationships,” Rizik said. “In part because they’re worried about going through what they went through two weeks ago.”
Larger banks are appealing for their stability, but smaller banks are the ones that approve more loans for most companies. Of small businesses that sought traditional loans at smaller banks in 2022, 82% were at least partially approved, according to the Fed Small Business 2023 Report on Employer Firms. At larger banks the figure was 68%.
The relationship business goes both ways. Naudon, president of Ponce, said companies that would normally be too large to apply for loans at his bank had come calling in recent months. Because of federal funding for Community Development Financial Institutions, including Ponce, some are flush with cash and ready to lend to inbound customers.
Renaissance Venture Capital/CoStar
Companies will likely start spreading out their deposits among multiple banks in the wake of the crisis, says Chris Rizik, CEO of the Ann Arbor, Michigan-based Renaissance Venture Capital.
The key for business owners is to capitalize on their existing relationships with their bankers, said Calley of the Small Business Association of Michigan. Those with a fairly new banking relationship could struggle.
Harris, the mobile spa owner, worked with a small-business development center at the Chicagoland Chamber of Commerce, which introduced him to a traditional bank.
“For me, it’s finding the happy balance of fintechs, like Square and PayPal, and finding a banker to work with,” he said. “As an entrepreneur, you have to be resourceful and more creative. I tell myself, ‘You made it through Covid: You can do this too.’ ”
Those forging first-time relationships with funders could feel the worst of it. Julie Roth Novack, founder of Chicago startup PartySlate, had just raised $4 million and deposited it in Silicon Valley Bank when the run on the bank began. After the Federal Reserve stepped in, she was able to move her money to new accounts at JPMorgan Chase and Chicago-based Wintrust. That raise was already in a hard environment. Venture funding dropped 31% nationwide last year and 61% in the fourth quarter from a year earlier, according to PitchBook data.
Things appear to be worse already.
“I’m hearing from founder friends who are having trouble raising their commitments (to invest) because of the SVB issues,” Roth Novack said. “I think it created some waves in the industry that [are] hurting founders even more. There’s a general sense that any increase in risk isn’t good for venture funding. It’s another ripple.”
Putting growth on ice
Companies in doubt about future funding are slowing their planned growth.
Irwin, the Chicago Realtor, said that for clients, the process of opening a new storefront is already the slowest he has seen, mostly residual delays from the past two years of supply-chain issues and soaring demand. He said he expects it to get even slower if and when banks become more conservative in their commercial lending practices. It is taking at least six months and up to a year to open a 2,000-square-foot restaurant, he said. Such long lead times mean lost revenue for the incoming business and the landlord.
Illinois-based Craveworthy Brands, owner of restaurant chains such as Budlong and Krafted Burger + Tap, hasn’t changed its plan to open more locations in the next several months.
But because of the banking turmoil, it will be much more cautious about which financing partners it chooses, said Larry Swets, an adviser to various Chicago companies, including Craveworthy.
“The banks may be less willing to work with you because they’re under more scrutiny (and) more pressure,” Swets said.
