Tight Credit Market: Impact On Banks and Your Business

At Turning Point we’re continuing to see a tight credit market in the regional lenders that we work with.  The restraint started shortly after Silicon Valley Bank (SVB) failed in March. This event, combined with economist sentiment predicting a recession later in 2023 or early 2024, created an environment where it made sense for lenders to tighten credit standards on new and renewing loans. As we near the end of 2023, it doesn’t seem a recession is upon us.  The Federal Reserve believes they have put inflation in check and the economy will be able to avoid a recession, as cited after the December 13 meeting, when Jerome Powell and the board decided to hold interest rates steady again. After raising rates by more than 5% over the last 16 months, the Fed praised itself on a job well done and discussed the possible easing of rates in 2024. Even still, as outlined in this article by Forbes the same week the Fed met, banks are continuing to tighten credit and cite a soft economy in 2024 as their primary concern.  The chart from the write-up indicates that most lenders are restricting credit in 2023 and state they will continue to do so into the first half of 2024. Some of these restrictions are also likely driven by a lack of capital at banks. Core deposits at banks (total deposits minus large certificates of deposit) are down $1.1 trillion, or 6% since February 2023. This impact may even be greater at smaller, regional lenders, who experienced a wave of withdrawals after the SVB failure caused many depositors to move money to larger, too big to fail, banks such as Chase and Bank of America. 

“Banks Making Fewer Business Loans Because of Recession Fears”, Forbes. Dr. Bill Conerly based on data from the Federal Reserve.

While banks tightening credit can reduce risk for the bank itself, it can also create risks for both the business borrowers and the lenders. This restriction can reduce needed working capital or critical investments in fixed assets which can impair earnings and credit worthiness. On a macro level, tighter credit conditions can make it more challenging for businesses to access financing, potentially slowing down economic growth. Therefore, the decision to tighten credit is typically a delicate balancing act that banks must undertake while considering both their own financial stability, the impact on specific borrowers, and the broader economic environment.

In a tight lending environment, it can become more challenging for business owners to secure loans or lines of credit. However, there are several strategies and actions that business owners should consider when navigating this complicated situation:

Step one is to communicate your financial position and operating results clearly and in a format that the banks can understand.  We often see financial statements that were created for internal use being provided to the bank.  They may be accurate, but the lender doesn’t recognize the format, they don’t look like GAAP statements, and this can cause concern.  We recommend that borrowers prepare concise GAAP financial statements that are accurate, up-to-date, and timely.  These need to include comparative balance sheets, income statements, and cash flow statements. Add your updated forecast reflecting any changes in the risks or opportunities to the business and provide a brief narrative that explains the financial results and any changes or material impacts in the forecast. 

We also recommend that you build and maintain strong relationships with your existing lenders and financial institutions. A long history of trust and open communication can be advantageous when working with a lender and their credit administration.   

Using alternative lenders can be a favorable option when a traditional lender is unable to provide the credit needed for the business. Asset-based lenders are often less restrictive on covenants and are focused on loaning against the company’s collateral such as accounts receivable, inventory, and equipment.  This type of loan can be more expensive, but it can be a helpful backstop when needed.  

If the purpose of the credit is to achieve the current business plan, it may be time to retract or slow down operations and focus on cost-cutting measures and improving cash flow to reduce your dependence on external financing. It always takes more capital to grow a business than to shrink it. 

Be prepared for potential delays or challenges in securing credit during periods of tightened credit conditions and consider adjusting your business strategy accordingly. If the necessary credit isn’t available, it may be time to seek advice from financial advisors, accountants, or business consultants who can help you assess your financial situation and determine appropriate financing options.

The lending environment of today may not be the same one tomorrow. Staying informed about market conditions that influence the availability of credit and maintaining a proactive approach to managing your business's finances is essential.