The Edge of a Straight Razor
Ben Nicholson
President, Fortis Business Advisors | Small Business Strategy, Turnaround & Restructuring, Exit & Liquidation Solutions
As expected, the Federal Reserve increased interest rates by another .75%. The prime interest rate will rise to 7.00%, which is up from 3.25%, the rate that ran from March 2020 to March 2022. Businesses with variable-rate loans are getting whacked, particularly those that originated in the past 2-3 years, and especially SBA loans.
In continuing the discussion on stress testing for margin compression (see below), we have been tracking the rate increase impact on an acquisition loan through the lens of the Debt Service Coverage Ratio (DSCR). While lending standards can vary slightly, a ratio of 1.25 (1.15 for SBA) has generally been considered healthy enough to originate a loan. However, as the ratio approaches 1.0, a borrower may be drawing cash from other sources to manage debt payments as they try to maintain covenants and avoid default.
With the new rate increase, our loan that started with a DSCR of 1.25 is now at 1.11. The same loan under an SBA structure will revise at 1.03 at the end of the year, and if there are additional rate increases, will drop below 1.0 come 2023.
...like a snail crawling along the edge of a straight razor.
It starts here: Stress Testing for Margin Compression During Economic Volatility And if you want to see the impact of the interest rate hikes, continue here: Effects from an Applied Stress Test. And if you want direct and effective recommendations to help, go here: "CHARLIE DON'T SURF!" - Riding a Wave Through Distress.
Vice President SBA Lending Officer @ Banc Of California | Accredited Small Business Consultant™ 972-469-2517
2yGreat Article!
Executive Vice President at Briar Capital Real Estate Fund LLC
2ywe are here if you need us!
SVP | SBA Division Leader at PB&T Bank - Helping Colorado companies gain and maintain access to capital to invest and grow.
2yThis illustrates that doing business with a bank that portfolios it’s SBA loans and offers adjustable or fixed rates makes a real difference for its clients. In today’s climate, as rates rise rapidly and real estate values begin to fall, clients with floating rates will struggle to repay and are unlikely to be able to do a conventional refinance, but clients that were offered adjustable or fixed rates can continue to focus on their business. If the LTV is under 85% and the loan was used almost entirely for purchase of real estate or capital equipment, it may make sense to investigate a 504 refinance and fix the rate before things get worse!
SBA Loan Consultant 770-653-9185 doug@sbaloanconsultant.com
2ySharing with my contacts. Great perspective!