The impact of inflation, threatening recession, and increasing interest rates on car wash borrowers can be challenging. This article will discuss some of the factors influencing business lending and what operators can do to improve their position.
Federal Reserve interest rate hikes are a tool employed to cool the economy and bring down inflation. This can put small-business owners across the country in a lending fix they have not experienced in a long time. If the Federal Reserve’s next moves match their signals, there could be more interest rate hikes by the end of the year. If the Fed does continue to elevate the cost of funds, it will bring business owners to a difficult set of decisions on whether to expand or just maintain current operations.
Car wash businesses are healthy today. This is especially prevalent in the express exterior model. Credit performance remains good throughout the car wash community. However, the Fed’s more aggressive turn against inflation can lead more operators to think twice about taking on new debt.
The reason is partly psychological. Many car wash owners have never operated in anything but a low interest rate environment. Even if their business cash flow remains healthy, the sticker shock on debt stands out more. In addition, there will be businesses that will find it harder to make cash flow match their monthly payments when the high inflation is impacting all of their other business costs, including the cost of goods and labor.
INCREASING INTEREST COSTS
Historically, when we have high inflation and increasing interest costs, we’ve seen traditional banks and credit unions tighten lending standards for conventional loans (loans not backed by a federal guaranty) and businesses begin to breach conventional loan covenants. Those covenants include the amount of cash flow needed to cover debt payments (cash flow coverage). When this happens, more business owners will need to turn to the SBA loan market. Every time we get into one of these cycles and the economy is slowing and rates are going up, one of the few places to get business credit is with SBA lenders.
But even in the SBA market, business owners can begin to pause as a result of the Fed’s rate actions. People are getting more cognizant about the cost of increasing interest rates and have greater concern the Fed will keep interest rates elevated.
WILL THE FED KEEP RATES HIGHER?
The big change this year, reflected in the stock market as well, is the acknowledgment that the Fed is not likely to quickly reverse its interest rate hikes. This is because inflation has proven to be stickier than previously forecast, and key areas of the economy, like the labor market, haven’t cooled fast enough.
Economists, traders, and business owners are hopeful the Fed will stabilize rates as soon as early 2023. Recent history plays to the narrative of rate stabilization. If we look at the last period when Prime Rate was on an upward spiral, this was between December 2018 and August 2019. During that time the Fed and economists were forecasting additional rate increases to the tune of 2 percent to 4 percent. Those rate hikes did not materialize. The Fed left rates unchanged for a period of 8 months, then they started to decrease the cost of funds.
Another indicator of rate stabilization could come from residential home sales. We have seen a huge increase in the cost of borrowing in the residential home market. Rates have more than doubled from what they were in January of this year. The impact of home mortgage rates on the economy should result in a slowdown in home sales and prices leveling or decreasing. This in itself won’t help home buyers or sellers, but it can start to help dampen inflation.
While nobody has a crystal ball, it is possible for rates to level out and then go down again.
SBA LENDING
Why would car wash operators turn to SBA lending? When times are good, there is a huge influx of both conventional lenders and SBA lenders to the car wash market. When the economy turns, lenders jump out of the market like rats jumping from a sinking ship. A perfect example of this was seen during the last recession. The number of lenders that bailed on the car wash market was unbelievable. Almost all of the current lenders proclaiming allegiance to the car wash industry were not here to support the market when things got tough. For those few lenders that remained loyal to the market, the primary loan products made available to car wash owners were loans backed by the Small Business Administration.
Unlike conventional loans, SBA loans do not have renewal periods. A renewal is when a lender evaluates your loan to see if they want to extend the loan or call the remaining balance due. Not having a renewal is key because if there is a short-term decrease in cash flow or real property value, SBA loans are not called due. On the flip side, conventional loans are generally evaluated for renewal every two to five years. If that renewal happens during a short-term downturn in the economy, the borrower can be required to pay-off the loan, sell their wash or be forced into foreclosure. This is why having a loan that is fully amortizing (no renewal periods) is important.
FIXED VERSUS ADJUSTABLE-RATE DEBT
One of the key reasons borrowers look at conventional lending is because most have fixed-rates. The misconception is that all SBA loans are adjustable. The truth is, most SBA lenders only offer variable rates that adjust quarterly. However, both the SBA 7(a) loan and the SBA 504 loan can have fixed-rate options.
As mentioned, most SBA 7(a) loans are adjustable. With that said, there are lenders that allow borrowers to lock in the rate for SBA 7(a) loans for a period of three to five years. This can give car wash owners the rate stability they need to get past a short-term economic downturn with the comfort to know the payment on their loan is not going to increase during that period.
SBA 504 loans are a hybrid combination of a conventional loan and an SBA loan. Approximately 60 percent is conventional and 40 percent is SBA. The SBA portion features a fixed rate for the entire 20- or 25-year term. The rate on the SBA portion is artificially low (typically at least 1 percent lower than the current market rate). SBA 504 loans are fully amortizing.
Both the SBA 7(a) and SBA 504 loans are fantastic options during times of economic uncertainty. They can be obtained in slower economic times and can have structures that surpass what are available for conventional loans.
INTEREST RATES AND EQUIPMENT FINANCING
With the recent jumps in the cost of borrowing for commercial real estate, we are at an unprecedented point when it comes to interest rates for equipment financing. For the first time in my 30+ years in business lending, rates for equipment financing are inverted when compared to commercial real estate financing. It’s actually less costly to finance equipment than real estate.
Since there is no guaranty this rate inversion will be available for the long term, it could be a good time for car wash operators to look at making those much-needed equipment upgrades. This is especially true when you consider the impact of the cost of labor and the opportunity to replace labor with automation.
DON’T WAIT TOO LONG TO ACCESS CREDIT
Car wash operators who have been through downturns before know that the time to access credit is before the economy and cash flow start to deteriorate. At some point, in the most severe downturns, those businesses with marginal cash flow may not be able to get the money they need to thrive or just to survive. If you act in a timely manner, you, too, can get the appropriate financing required to maintain or grow your car wash business.
For additional information on lending programs available for car wash operators, please feel free to contact Michael Ford, managing director at Coast Commercial Credit™ at (800) 400-0365 or MikeF@CoastCC.com.