Experts have recently expressed concerns regarding a significant increase in bankruptcies among family businesses, with filings rising by 18%. However, the situation is far more intricate than it appears, as various factors come into play and impact middle-market companies. The struggles faced by small businesses can create ripple effects that extend throughout the broader economic landscape, highlighting the interconnectedness of companies of all sizes.
Effect on the Middle-Market
The market is witnessing a surge in small business bankruptcies due to high-interest rates, slim margins, and market fragility. This trend may also threaten middle-market companies, raising concerns about their financial stability and prospects.
1. Rising Interest Rates
Middle-market firms are disproportionately affected by rising interest rates, with the Secured Overnight Financing Rate (SOFR) reaching an average of 5.01449. This signals potential panic as these high-interest rates are likely to impact middle-market companies, forcing them to reevaluate their financial strategies and potentially leading to decreased investments and constrained growth opportunities.
2. Higher Debt Costs
The increasing cost of debt can reduce an average business’s profitability (EBITDA), and floating-rate loans exacerbate the issue. With those increased rates, middle-market companies could eventually feel the effects. Exploring fixed-rate bonds with larger counterparts could offer some relief in the future, providing middle-market firms with more excellent stability and predictability in their financial planning.
3. Reduced Liquidity
Middle-market firms face liquidity challenges due to increased debt service costs, higher wages, and logistical complexities. The need for more skilled individuals further hinders their ability to stay competitive. Over 10 million job vacancies in companies with fewer than a thousand employees add to the current crunch. Growth is only possible with people to fill the job openings.
Upcoming Challenges
In the current economic climate, several challenges loom ahead, including a potential credit crunch, rising loan defaults, and various financial pressures that may impact different sectors in distinct ways.
Credit Crunch
Recent public bank failures raise concerns about a credit crunch, which might reduce lending to small and mid-sized businesses. This situation could be influenced by the Federal Reserve’s standardized approach to estimating credit risks, leading to higher credit requirements for smaller banks. Small to mid-size banks hold nearly 40% of loans and debt at small to mid-size companies. It is still being determined whether a credit crunch will occur due to the recent bank failures. Congress is holding hearings to discuss this issue with representatives from the Federal Reserve, which has hinted at using a standardized approach for estimating credit rather than relying on estimates. Businesses should be prepared for the possibility of a credit crunch, and decisions may unfold quickly once the storm hits.
Loan Defaults
The forgiving approach to loan defaults is gradually coming to an end. While we have moved away from the spike observed in late 2020 and early 2021, the trend of leveraged loan defaults persists, with a default rate of 1.86%, up from nearly 0% in June 2021. This may have repercussions on banks and borrowers for years to come, potentially leading to tighter lending standards and increased scrutiny of borrowers’ creditworthiness.
Economic Pressures
While there is no need for widespread pessimism, some sectors will experience the impact before others. Commercial real estate should brace for challenges, while agriculture faces high-interest rates and weather challenges. Meanwhile, packaged foods may find stability amidst inflationary pressures. Understanding the nuances of the economic landscape will empower businesses to navigate through uncertainty and find growth opportunities. By collaborating with Calvetti Ferguson, companies can harness their expertise to make informed decisions, seize emerging growth opportunities, and explore restructuring options as needed.
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Calvetti Ferguson works with middle-market companies, private equity firms, and high-net-worth individuals nationwide. Our experience allows us to define key roles, responsibilities, and timelines to meet those needs. We leverage skilled team members and efficient technology to build an effective solution tailored to a company’s organization and reporting structure. Regardless of the complexity of the compliance, assurance, advisory, or accounting need, our team stands ready to assist you.