By Kevin Centofanti,
Brooks Houghton & Company, Inc.
In spite of inflation, a devastating war in Europe, and a volatile market for months, the US debt market was fairly robust at the beginning of this year.
But they sure didn’t stay that way for long.
As we get deeper into 2023 and the Fed continues to increase interest rates, the bar for borrowing money has grown precipitously higher, and approval rates for business loans have dropped significantly since the year began—especially for small and medium-size enterprises (SMEs).
According to the Biz2Credit Small Business Lending Index™, big banks have dropped their loan approval rates for small businesses from 14.4% in January 2023 to 14.2% in February. SME loan approval rates from small banks have dropped even more dramatically in the 1st quarter of this year, from 21.3% in February to 19.1% in March.
Along with the collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank, the sense of uncertainty and unease in the lending market is currently—to say the least—precarious at best. What’s more, the fear of additional failures among regional and smaller banks continues to fuel fears among borrowers and lenders alike.
The House isn’t On Fire, but 2023 is an Incendiary Year for the US Debt Market
Although the Fed can’t ease off on increasing interest rates for now, business lending is still a viable means of raising capital today; however, unless businesses understand how the rules have changed in the current US debt market, higher borrowing costs could squelch—unnecessarily—what would otherwise be smart and timely business decisions.
Here are six trends that are impacting the debt market today and are likely to continue throughout the remainder of 2023.
- The bar for approval rates is now higher for all borrowers—SMEs and multibillion-dollar companies alike.
- Non-bank lenders may be more flexible and easier for SMEs to secure loans from, but they’re pricier than traditional banks.
- Companies that aren’t in a favorable financial position to ask for additional funding will find it difficult to secure favorable credit terms.
- The amount of funds from asset-based lending will be smaller, regardless of a company’s EBIDTA. This is being driven by lower valuations in the public and private markets. Overall, the trend will lower the borrower’s debt capacity.
- For sell-side transactions, instead of the traditional combination of 70% debt and 30% equity provided by private-equity investors, we’re now seeing something closer to a 50/50 debt-to-equity mix. This is forcing private-equity investors to put more money into their deals, which, of course, also drives down returns.
- Small and more nimble banks are more likely to offer better lending terms than larger ones, especially if these particular banks have deep experience in the borrower’s sector.
Not all of these trends are necessarily negative, and for the most part, inflation does seem to be slowing down overall. But as far as the US debt market is concerned, we’re still not out of the woods for the foreseeable future.
So, for any business or investor looking to raise capital this year, the best possible advice is to start the process now, rather than later, to avoid any lender pushback.
Will the US debt market be in a much stronger position than it is today by the end of the year? We think so, but it already offers opportunities—even if they’re fewer—for well-managed companies with solid business models to find the capital they need to achieve their 2023 funding goals.
Kevin Centofanti is President, Chief Compliance Officer, and Principal at Brooks, Houghton & Company, a New York-based merchant banking firm that provides investment banking and direct investment services to middle-market companies. As a member of Globalscope, Brooks Houghton offers access to a global network of experts who can help companies navigate the more restrictive lending environment businesses are facing this year.