Are SME Lenders facing a ‘perfect storm’?

SMEs are often seen as the backbone of the UK economy but with inflation back at 10.1 per cent, hovering at a 40-year high, the economic strain is starting to be felt. 

“The cost of doing business crisis is biting hard, driven by energy bills, fuel prices, rising input costs, increasing labour costs, and high taxes,” said Martin McTague National Chair of the Federation of Small Businesses (FSB).

Research from the FSB shows that from spring through to summer nearly nine-in-ten small firms were reporting higher costs. 

“We’re also seeing growing numbers of small businesses seeking finance to help with cashflow. Without further support in the coming months to ease the soaring costs, there is a real danger that we will see more previously healthy and strong small businesses struggling to make ends meet,” McTague said.

This is feeding through to more demand for lending from SMEs to meet their growing costs.

Managing day-to-day cash flow has become the primary reason for small business applications for finance, according to Iwoca, which surveyed over 3000 small business finance applications submitted in September, with SMEs principally worried by soaring energy prices. 

“The challenging economic environment has hit small businesses everywhere. They’re needing to manage cash flow in the face of rising business costs, as well as having to consider the cost of borrowing,” said Colin Goldstein, commercial growth director at Iwoca.

Much of this strife was prompted by the inflation seen around the world. But there is also a UK - specific issue relating to the recent political volatility and its knock-on effect on markets.

Sean Brophy, head of SME debt finance at Triple Point, which lends to SMEs directly as well as funds other lenders such as Capital on Tap, told AltFi that before the notorious ‘mini budget’ that precipitated the fall of the Liz Truss government, SMEs were already in “a bit of a perfect storm”. 

“Supply chains were coming under pressure. They were trying to pass cost increases onto clients and depending on what place they are in the market some could do that more easily than others. Recruitment is an issue, and retention is a massive issue.” he said, 

“You’ve got pressure in supply chains, pressure with your client base, pressure, retaining and recruiting staff. When you factor in all of this uncertainty, there are huge difficulties,” he added.

When this is layered onto the most recent machinations in politics the issue is further compounded. 

Brophy says while SMEs are generally very resilient businesses, the turmoil comes at a time when SMEs are more highly leveraged than they ever have been with about £20bn more of debt sitting on the balance sheets of UK SMEs than there historically has been 

“Businesses' balance sheets are not in a great position anyway, they've taken on debt, and they've taken on debt based on base rate lending. Not only are their balance sheets not great, but their P&L is going to come under huge pressure because their interest payments are going to be way more than they ever would have expected them to be,” he said. 

This, he says, is a direct result of last month’s ‘mini-budget’.

“When you factor in that SMEs, in general, were not in a great place or, have lots of external pressures and then layer on top of what happened [with the ‘mini-budget’], it does feel like a perfect storm,” he added. 

The challenge

Cashplus Bank, a lender to both businesses and consumers that recently became a bank after more than a decade as an alternative lender, says the cost of living is hurting smaller businesses’ revenues.

Strong gains made by these micro businesses in growing their income over the past 12 months have now been wiped out by even faster-rising expenses.  

Cashplus’ data show that many micro-SMEs have performed strongly over the last 12 months, but that recent inflationary trends have seen growth in costs outpacing growth in income.

The lender analysed income and spending data from its 150k SME customers recently. It found since the start of 2022, in particular, businesses have faced growing costs for energy, fuel, and recruitment.

While income and outgoings were broadly flat over the 6 months from August 2021 to February 2022, small businesses have seen outgoings rapidly increase after February of this year when the Russian invasion of Ukraine began. By August these were up about 21 per cent year on year. 

Encouragingly, the income also increased strongly over this period, growing at 25 per cent but the trend has now reversed and over the six months from March-September income grew by 8 per cent but was outstripped by cost growth at 10 per cent, with 0.8 per cent growth in outgoings vs a 1 per cent drop in income from August to September.

“While the micro business population is diverse and varied, it’s obvious that this vital part of the UK economy is feeling the squeeze of the cost-of-living crisis. Small businesses will be seeing margins under real pressure as basic, unavoidable day-to-day costs increase, meaning otherwise-healthy businesses will be tipped into lossmaking,” said Rich Wagner, CEO, Cashplus Bank said. 

“With added uncertainty over energy costs from April next year, many small companies will be deeply concerned that the cost of doing business will become unmanageable,” he added. 

Silver linings

Brophy advises lenders and borrowers to focus on the shorter-term economic situation. 

"You want a really good handle on what you think is going to happen over the next 12 months. You can forecast five years out, but it's all kind of fantasy. That it makes very difficult." 

"From a lender's perspective, you've got to be a little bit more conservative, you got to allow yourself some more headroom in terms of running sensitivity analysis on what you think a business can do."

It is not all doom and gloom, however. He adds that despite all the negative data and sentiment, SMEs are generally good at navigating crises.

"My experience in lending to SMEs over a fairly long period of time is that they tend to be far more resilient than you would have ever expected. The resilience comes from the owner-managers who run the business as if it's their own personal baby. There's an intangible value to that, which means that businesses can trade through tricky positions in a way that you potentially wouldn't expect them to."

"There is also flexibility so finding a route into new markets or doing things that you potentially wouldn't need to do in benign market conditions. That's probably what makes SMEs segment a bit more resilient than you would think."

Let's hope it includes perfect storms.