US SMEs shut out of credit boom, stalling nascent rebound

Washington

UNPRECEDENTED government stimulus has allowed more companies to borrow at lower rates than ever before. Yet amid the credit boom, smaller companies that power America's economic engine are often being shut out, hamstringing the recovery just as it begins.

The Federal Reserve's pledge to use its near limitless balance sheet to buy corporate bonds has aided stricken airlines, oil drillers and hotels. It has also helped companies from Alphabet and Amazon.com to Visa and Chevron access some of the cheapest financing ever seen.

All told, firms have sold about US$1.9 trillion of investment-grade debt, junk bonds and leveraged loans this year, according to data compiled by Bloomberg.

But for companies not large enough to tap fixed-income markets, the outlook is much more dire. Banks are tightening conditions on loans to smaller firms at a pace not seen since the financial crisis, while many direct lenders that have traditionally focused on the middle market are pulling back or turning to bigger deals instead. What's more, the Fed's emergency lending programmes for mid-sized businesses and municipalities have been criticised as slow, complex and largely inaccessible.

A lack of credit for small and medium-sized enterprises (SMEs) could tip many into bankruptcy, adding to the thousands of local businesses that have already quietly disappeared amid the pandemic's mounting devastation. Given that the sector employs roughly 68 million Americans - Fed chairman Jerome Powell calls it America's "jobs machine" - and is critical to regional economies across the US, a prolonged inability to access financing runs the risk of stalling the nascent rebound.

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"The Fed actions have moved issuers that are big enough in front of the velvet rope, and those that aren't stay outside," said Peter Atwater, founder of research firm Financial Insyghts and an adjunct lecturer of economics at university William & Mary. "Capital markets access has become a determiner of life or death for business."

That is not to say the Fed's current policy approach is necessarily misguided. In fact, many economists commended its quick and decisive actions when the pandemic hit and said those bold steps were key in staving off another financial crisis and possibly even a depression.

But amid such large-scale intervention, certain parts of the economy are clearly benefiting more than others - the big and powerful over the small and financially vulnerable, a disparity that to some degree mirrors the broader inequality problems that have been exposed by the pandemic.

Some 70 per cent of bank senior loan officers surveyed by the Fed said they have tightened lending standards on loans for small commercial and industrial firms in the third quarter. That is the highest proportion since late 2008. The trend also extends to mid-size and larger firms as well, though the latter enjoy unprecedented access to capital markets. About 54 per cent said they increased premiums for small borrowers, the most in over a decade.

"Everyone is willing to lend to the biggest firms," said Olivier Darmouni, a professor of finance at Columbia Business School. "But since the pandemic has not been tamed, creditors are now asking if the businesses will actually survive and they'll get their money back. For smaller firms, there's a lot more uncertainty of that."

In a bid to encourage banks to extend credit to mid-size firms, the Fed introduced its US$600 billion Main Street Lending Program in April, wherein those making eligible loans can sell 95 per cent of them to the central bank. Despite efforts to broaden the programme, it has issued just US$253 million in loans as at Aug 10. That has compounded criticism that it only works for a narrow set of companies, is too complex and does not provide enough incentive to risk-averse lenders.

Boston Fed president Eric Rosengren said on Wednesday that as borrowers and banks become more familiar with the programme, it is seeing a steady increase in participation, adding that it may become even more essential should the coming months bring a resurgence of the virus.

Still, the facility stands in contrast to the Paycheck Protection Program (PPP), run by the Small Business Administration and the Treasury, which doled out more than 5.2 million loans totalling US$525 billion before closing last week. The PPP facility, for its part, has gotten its own share of criticism, with some saying the smallest companies and those in disadvantaged areas have been shut out, while politically connected businesses and firms that are not struggling have gotten funding.

Making matters worse, direct lenders, which often provide financing to SMEs, have been retrenching for months as they tend to their own portfolios, while those sitting atop the most capital are increasingly targeting bigger deals.

A growing chorus is also warning on inflation, which can hit smaller firms particularly hard. One of those is Larry McDonald, founder of The Bear Traps Report investment newsletter.

"It's an inequality explosion in terms of financial sustainability," said Mr McDonald, who also authored the book A Colossal Failure of Common Sense about the demise of Lehman Brothers Holdings. "You have financial conditions tightening in some spots, and then wide open for the big guys - it's crazy." BLOOMBERG