The National Federation of Independent Business has surveyed its member firms (350,000) since 1980 about credit market conditions and the rates they pay on short-term loans (12 month maturity or less). The average rate reported has been stuck between 6 percent and 6.5 percent since January, 2009. This has occurred in spite of massive Fed intervention in the form of liquidity-providing purchases of assets (mostly Treasuries and mortgage-backed securities) to lower rates paid by small businesses.
With the Fed maintaining a “0” rate target, it is hard to see how the Fed could drive borrowing rates for small firms any lower. This is because the cost of funds for community banks is not driven by just the Federal Funds rate. Their business model is built around relationship lending and information that is not contained in a D&B report or a credit report, such as the quality of the management team, prospects for growth in the geographic area, and more.
This is a more labor intensive, and fixed capital intensive operation, but one that provides a service that is valued by borrowers and apparently not available from larger financial institutions (each of the very large banks has about as many branches as there are independent financial institutions in operation).
Most if not all community and regional banks have put floors on the rates they will offer on business loans and equity lines of credit that reflect these cost differences. When market rates are at historic lows, it is risky for small banks to make longer term loans at historically low fixed rates.
If rates rise as most observers expect, the value of low rate loans on the banks’ balance sheets will not perform well and earnings will be impaired. So in addition to periodic re-sets, floor rates are in place and it will be difficult if not impossible for Fed policy to push longer term loan rates below those floors.
That said, loan rates are historically low and the cost of funds is not preventing firms from borrowing. Rather, it is the lack of good uses for borrowed funds that is depressing loan demand. Loans must be repaid and so must be used in ways that at least return the principal amount of the loan and those opportunities are few in this economy.
Most firms see little or no improvement in the economy in the coming year, so no need to borrow to invest or hire. It will take time and an election to change this.
William Dunkelberg is an Economic Strategist, Boenning & Scattergood and Chief Economist, National Federation of Independent Business.