A credit crisis among small businesses risks creating an even more lopsided US economy
Robin Wigglesworth
A business loan supported by the US central bank’s emergency Main Street Lending Programme will help support Mango’s through Covid-19-induced difficulties © Bloomberg
Mango’s, a tropical-themed nightclub in Orlando that boasts the city’s “sexiest beats”, was recently saved from Covid-19-induced bankruptcy by the Federal Reserve.
A business loan supported by the US central bank’s emergency Main Street Lending Programme will help keep the hotspot alive until dancers and drinkers eventually twirl back to its venues. “We shall reopen to sing, dance, dine and entertain again when it is safe to do so,” the company promises visitors on its website.
Unfortunately, Mango’s rescue is an outlier. While the Fed has engineered a lavish party for America’s biggest companies, its smaller businesses are increasingly forced to scramble for scraps falling off the table, as access to credit becomes a case of feast or famine.
To ease the economic impact of the Covid-19 pandemic, the US central bank has since March unveiled a series of monetary measures unprecedented in size, speed and extent. The most eye-catching move was to start buying corporate bonds. Although its actual purchases have been modest, the mere fact the Fed is doing this has nurtured a borrowing frenzy. US companies have now sold nearly $2tn of bonds this year, already smashing past last year’s total.
Despite the bond spree, the average cost has sagged to or near all-time lows. Even riskier non-investment grade companies, often termed “junk”, have been invited to the Fed’s fiesta.
Aluminium can maker Ball recently sold a $1.3bn junk bond with a coupon of just 2.9 per cent, the lowest rate ever paid by a non-investment grade company. For an asset class usually given the more favourable “high-yield” moniker, a rebrand may now be necessary.
However, in the humbler reaches of corporate America, where companies are far too small to issue bonds, access to credit has become a more Darwinian struggle. Rising corporate debt inequality is a longstanding trend but the coronavirus crisis has exacerbated it and thrown it into painfully sharp relief. Size, far more than creditworthiness, now dictates access to credit.
Despite the bond boom, the Fed’s latest survey of bank loan officers revealed that a net 70 per cent of bank loan officers were tightening conditions on bread-and-butter corporate loans — making this the deepest credit crunch since the depths of the financial crisis. The mushrooming industry of private debt groups is also increasingly focused on bigger companies, not the smaller ones that most desperately need funding, widening the gap between the credit haves and have-nots.
The diverging access to credit is now so extreme that political and regulatory action is arguably warranted
This is a global phenomenon. The Bank for International Settlements estimates that companies with revenues of $1bn or more account for 70 per cent of all borrowers in the corporate bond and syndicated loan markets in the year to May, close to the highest in a decade. But it is particularly acute in the US, where bonds do more of the heavy lifting than in Europe and in Asia, where smaller companies generally have access to more vibrant local banking systems.
The good news is that the spike in corporate bankruptcies has thus far been more moderate than feared. Nonetheless, it is no coincidence that the historical outperformance of smaller listed companies has disappeared in the US over the past decade and even reversed this year, after nearly a century of faster average gains. Big has become better.
The Fed’s MSLP, aimed at businesses with fewer than 15,000 employees or $5bn of revenues, is an admirable and innovative effort to address this issue. But it is complicated for smaller, often less sophisticated borrowers, and relies on local banks arranging the loans and selling them on to the central bank.
This explains why a mere $530m had been lent through it by August 4, with another $421m under review, according to the Boston Fed, which administers the programme. The Paycheck Protection Programme run by the Small Business Administration and the US Treasury made 5.2m loans worth $525bn between its establishment in April and closure earlier this month.
The MSLP take-up will undoubtedly improve, as borrowers and banks become more familiar with it. Yet it remains a Band-Aid for the coronavirus crisis, rather than something that will durably improve access to credit for smaller businesses in the US.
The diverging access to credit is now so extreme that political and regulatory action is arguably warranted, not just to help keep smaller companies alive in the short run, but to prevent the US economy from becoming even more dangerously lopsided.
Perhaps it is time for politicians to make small business loans structurally more attractive for banks and other lenders through generous regulatory or tax system breaks. That might come at a cost of more dud loans, but the economic benefits outweigh the risks.
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