Did High Leverage Render Small Businesses Vulnerable to the COVID-19 Shock? 
Large income losses in the early months of the COVID-19 pandemic jeopardized the survival of small and midsize firms, especially those that had accumulated considerable debt relative to income during the period of low interest rates that preceded the pandemic. Even if widespread failure could be avoided, the pandemic’s adverse effects on the real economy still may have been amplified and the eventual recovery depressed, if, after the COVID-19 outbreak, highly levered small and midsize firms faced tighter constraints on accessing bank credit to fund employment, investment, and growth. This paper uses a loan-level supervisory data set containing information about the majority of commercial and industrial loans issued by US banks with more than $100 billion in assets to analyze the effects of pre-pandemic corporate leverage on the credit conditions faced by borrower firms during the pandemic.
Key Findings
- The credit conditions of small firms with high leverage were negatively affected during the pandemic. These firms received smaller loans and faced a lower probability of being granted new loans by banks from which they had not borrowed previously.
- Regardless of how highly they were levered, large borrower firms that were either new or existing customers of a large bank were more likely to obtain bank loans after the COVID-19 outbreak compared with small firms.
- The unprecedented public support provided by the US government and the Federal Reserve, particularly the Paycheck Protection Program, improved the credit conditions for small firms that otherwise would have had difficulty accessing bank loans.
- Banks with larger excess capital at the onset of the pandemic were able to provide more credit to their existing small and midsize customers, including those that were highly levered and operating in industries severely affected by the COVID-19 outbreak.
- Better-capitalized banks seemed to have been less willing to lend to new customers during the pandemic, perhaps due to greater aversion to uncertainty—the same factor that may have prompted them to accumulate more excess capital.
Implications
Credit conditions for small firms with high pre-COVID leverage were most negatively affected during the pandemic. The unprecedented public support, specifically the Paycheck Protection Program, substantially improved the credit conditions faced by small firms. The paper’s analysis also provides evidence that well-capitalized banks were more capable of supplying much-needed credit to bank-dependent small and midsize firms following the crisis. Overall, the paper’s findings highlight the importance of rigorous capital regulation during normal times and policy measures that support the flow of credit to small businesses, including those that are highly levered but nevertheless viable in the long run, following a severe exogenous adverse shock.
Abstract
Using supervisory data on small and mid-sized nonfinancial enterprises (SMEs), we find that those SMEs with higher leverage faced tighter constraints in accessing bank credit after the COVID-19 outbreak in spring 2020. Specifically, SMEs with higher pre-COVID leverage obtained a smaller volume of new loans and had to pay a higher spread on them during the pandemic period. Consistent with an inward shift in loan supply, these effects were concentrated in loans originated by banks with below-median capital buffers. Highly levered SMEs that relied on low-capital large banks for funding before the pandemic were not able to substitute to other sources of debt financing and thus experienced more of a reduction in total debt as well as a decline in investment and employment. On the other hand, the unprecedented public support, especially the Paycheck Protection Program (PPP), mitigated the adverse real effect stemming from bank credit constraints.