SME Optimism Teeters — Should The US Be Worried?

U.S. small businesses are feeling pretty good right now. The latest research from Capital One found half of small businesses in the country feel either “good” or “excellent” about current business conditions — a 9 percent increase from a year ago — and the same portion also said they expect those conditions to improve in the next six months.

Meanwhile, data from Biz2Credit’s latest Small Business Lending Index, released last week, found small business loan approval rates at small banks and institutional investors saw increases in March, with big bank approval rates holding steady.

But the Index also raised the issue of the federal interest rate and how another increase may make an impact on SMEs.

“The Fed’s recent announcement that it wants to start unwinding the $4.5 trillion in bonds on its balance sheets bodes well for banks,” stated Biz2Credit CEO Rohit Arora. “It signals that the economy is strong and will likely result in yet another interest rate hike. Since a majority of small business loans are linked to U.S. prime interest rates, this will improve spreads at banks will providing more incentives to approve funding requests.”

It’s good news, but some analysts note that an interest rate hike may actually dampen the optimism streak currently enjoyed by the nation’s small businesses.

Research by Dun & Bradstreet and the Pepperdine Graziadio School of Business and Management, also released last week, warned that economic outlook may be less positive for SMEs with a federal interest rate increase. In their 2017 Private Capital Access Index report, Dun & Bradstreet and Pepperdine found that mid-sized businesses, with between $5 million and $100 million in revenue, reported a decline in profitability as well as their inability to hire new staff as a direct result of higher interest rates.

Indeed, profitability for mid-sized firms declined six percent for Q1 2017 compared to the previous quarter. Further, 27 percent said the current financing environment prevents their ability to hire new employees in Q1, up from 20 percent in Q4 2016.

Small businesses, meanwhile, are faring a bit better. Firms with annual revenue of less than $5 million remain optimistic about the economic situation even as federal interest rates increase, with 53 percent of small firms reporting they were profitable in Q1 2017, up from 50 percent in Q1 2016.

“We’ve been seeing increased optimism from small and mid-sized businesses, so the finding that fewer small businesses operated at a loss in Q1 2017 and more operated at a profit, compared to a year ago, was a welcome result of improved business conditions,” said Craig R. Everett, PhD, director, Pepperdine Private Capital Markets Project at the Pepperdine Graziadio School of Business and Management. He told PYMNTS, though, that some of the latest data did come unexpectedly. “What did surprise us was that the Fed’s Interest rate hike seemed to affect mid-sized businesses more than small businesses,” he explained.

According to Everett, the data suggests that these impacts are a result of the December 2016 federal interest rate hike; in March, the Fed bumped rates again by 0.25 percent, with another likely increase on the way.

All of this is likely to show up as having an impact on SMEs in the following PCA Index, he added.

“If small businesses envision cash flow difficulties in the near future, they should consider strategies to hedge against the need to borrow, like maintaining the healthiest reserve possible and not committing to expenses before revenues are realized and banked,” he explained. “As long as optimism is tempered by caution, and access to capital doesn’t significantly decrease, impacts on growth should be minimized.”

Recent months have given rise to dozens of headlines about the increase in small business optimism, fueled largely by President Donald Trump and promises to promote SME health and limit red tape for lenders.

But a closer look at the data shows that SMEs remain concerned about several elements within the national economy.

For interest, data released by Capital One found muted hiring expectations, with just 27 percent of small business owners planning to increase hiring in the next six months. Several regulatory issues are weighing heavily on the minds of these small business owners, with half citing taxes as the top factor that will impact their company; minimum wage increases, access to capital and immigration reform were also all cited by small business owners.

Other data released last week from the National Federation of Independent Businesses for its Index of Small Business Optimism found an overall decrease in small business optimism for March 2017, following an Index high in January following the election.

“More small business owners are having a difficult time anticipating the factors that affect their businesses, especially government policy,” reflected NFIB Chief Economist Bill Dunkelberg in a statement.

According to Everett, there are some clear concerns for SMEs, though.

“I think they’re juggling a combination of business concerns and regulatory concerns,” he told PYMNTS. “SMEs report concerns with costs related to the ACA and minimum wage increases, but only 8 percent cite ‘tax and regulatory policies’ as one of the most significant business challenges for 2016. Twenty-four percent say that finding and retaining profitable customers was their biggest challenge, and 16 percent named finding and retaining a quality workforce.

“That suggests to me,” he continued, “that businesses are focused on growing their operations, rather than finger-pointing at state and federal regulators.”

The truth is, though, that federal policy will continue to impact SMEs, whether by affecting access to capital or otherwise. Everett said that is a part of economic reality — but that SMEs are in a position to continue the long-awaited effects of economic improvement.

“There is an old adage that Main Street experiences economic downturns first and experiences recoveries last. This appears to be truer than ever,” he said. “Relief takes some time to trickle down from Wall Street, so the fact that optimism has infiltrated SMEs is a valid sign that they’re feeling the recovery and their financial health is improving.

“If they’re able to maintain this trajectory, keep hiring, access financing and increase profitability, then they’ll continue to be a driving force in their local economies and the American economy as a whole,” he concluded. “If any one of these factors is disrupted, especially hiring, it could create a domino effect that results in another period of economic stagnation.”