Now Is the Time to Pursue Opportunities in Small-Business Lending

As interest rates remain high, concerns about credit risk and borrower health are top of mind for bankers, especially as it relates to small-business lending. In conversations with community banks and credit unions across the country, we’re hearing about a significant increase in line utilization, raising questions about liquidity and credit risk.

However, recent data from Abrigo shows that privately held companies across the U.S. are proving to be financially resilient. While they are borrowing more, they’re also managing their leverage and meeting debt obligations — even as they feel the pressure of high rates.

For bank directors, this data would indicate that there are opportunities to grow the small business portfolio in a safe and sound manner, particularly with rates apparently peaking.

Here are my takeaways on the health of small-business borrowers, based on Abrigo’s real-time database of private-company financial statements.

Nearly all U.S. businesses are privately held, and most are small, so a view into how these companies perform provides bank leadership teams with insight to make informed decisions about the large and growing small business market.

Steady Debt Service Coverage Despite Rising Rates
The debt service coverage ratio (DSCR) is a fundamental measure of cash flow strength. Abrigo’s latest data shows that, even with a 350-basis-point increase in interest rates, the average DSCR for privately held businesses was 5.75x in 2023, nearly unchanged from 2019. Businesses are feeling the pinch but handling it well, with enough cash coming in to service debt as contractually agreed.

Improved Leverage Levels
Many businesses have taken a more cautious approach to borrowing in the rising rate environment. Abrigo’s data shows that the debt-to-equity ratio has fallen from 4.10x to 3.45x between 2019 and 2023. Despite increased utilization, the reduction in leverage indicates that companies are prioritizing financial stability. Leverage decreased, showing that companies are not overextending themselves.

Longer Working Capital Cycles Drive Line Utilization
Businesses are holding inventory longer (81 days in 2023 versus 72 days in 2019) and extending receivables (from 31 days to 41 days). Those trends have driven an increase in days needing financing from 77 to 93 days. Companies are borrowing more to cover operational costs, but they continue to pay suppliers on time, with payables remaining under 30 days. Companies need more working capital, but they’re still paying their suppliers as they should.

Strong Interest Coverage
Interest coverage ratios, another critical indicator of a company’s ability to meet interest payments, have remained strong. Interest coverage rose slightly, from 10.67x in 2019 to 10.80x in 2023, indicating that the increase in interest rates hasn’t derailed businesses’ ability to meet interest expenses.

The preliminary data indicates that the increase in rates and the end of stimulus measures are finally being felt. The rate cut in September came at just the right time to prevent further financial stress. Early 2024 figures show a dip in DSCR to 4.62x. However, leverage continues to improve.

Historically, increased line utilization, particularly in somewhat benign times, has been a cause of concern since higher utilization can reduce a borrower’s dry powder for downturns. However, Abrigo’s data shows that businesses are meeting obligations and reducing overall leverage.

As banks weigh small business portfolio expansion, monitor loan demand and assess the health of borrowers, private companies’ financial condition sheds light on the option of adding new, creditworthy borrowers in a higher-rate environment.

The Board’s Role in Guiding Supportive Lending Practically
Directors play a key role in guiding portfolio growth by setting policies that allow banks to respond to business owners’ cash flow needs while balancing risk and growth objectives. The real issue for many bank leaders is how to incrementally and profitably add to that portfolio.

Investing in small-business lending technology such as automated loan processing that allows for easy lender intervention and supports Section 1071 reporting can foster growth in a way that enhances risk management. Automating administrative tasks lets lending teams dedicate more time to building client relationships, making informed decisions quickly, and maintaining compliance with minimal disruption.

Privately held companies are showing that they can adapt to today’s economic climate. By leveraging data on their business performance, banks can confidently offer client-centered solutions that reinforce trust and strengthen their role in helping small businesses and their communities continue to thrive.