Credit Outlook

Down Shifting

Booming had been the story about Main Street America with the releases of data for most of 2018. Booming is proving to be short-lived as we see in this latest report. Main Street America had been on a tear showing double-digit increases in borrowing and investment starting in October 2017 and increasing at double-digit rates through 11 months of 2018. The latest reports break that streak and send a message that we are familiar with: Main Street can’t continue at double digit investment rates indefinitely, so a slowdown was expected. But the slowdown to healthy 5% growth we saw in November has rapidly shifted into outright contraction in December and back to single digit in January. The downshift may go down in history as noteworthy due to its severity and rapidity. In one month, we’ve seen Main Street jam on the brakes and pull back on borrowing and investing and then shift gears into a lower speed. This is particularly striking in the big industry sectors that make up the majority of Main Street businesses.


Business Cycle

The Expansion phase took a turn south in this latest release. Figure 1 shows investment in Q4 further fell versus the prior quarter while credit risk ticked higher slightly. While lower, we are not concluding a sea change in the expansion cycle. Figure 1 also shows prior years (2013 and 2016) where expansion fell and credit risk rose. But taking the longer term view, we can see with 20/20 hindsight that those prior two dips with slightly higher risk was a pause. In 2013 and 2016, the slight downturns allowed private companies to regroup and continue expansion a few quarters later. Q3 and Q4 of 2018 are exhibiting the same trend of pullback with slight upticks in credit risk. Whether this is a pause or a start of an extended contraction remains to be seen, so we are not making any predictions at this point.


Business Cycle

Figure 1: PayNet Small Business Cycle



Recent Investment Activity

PayNet’s Small Business Lending Index (SBLI) fell in December -7% versus the same time in the previous year. On a month-over-month basis, the index is down -10%. This is the first outright contraction of the Index since April 2017 and breaks a 20-month expansion streak. As a result, the SBLI ends the year effectively wiping out the investment gains that had been achieved by Main Street Companies in 2018.

In January The PayNet Small Business Lending Index (SBLI) seasonally adjusted originations increased +5% compared to January 2018. The rolling three-month index at 142.6 is up almost 1% compared to December 2018 and up 2% compared to January 2018.

Outright contraction is now found in four of the 10 largest industry sectors.



PayNet Small Business Lending Index

Figure 2

PayNet Small Business Lending Index Year-Over-Year Change

Figure 3


Credit Risk

PayNet’s Small Business Delinquency Index (SBDI), which measures loans 31-90 days past due, rose 0.02% over the prior month to 1.45%. SBDI is up 0.08% versus the same month in the prior year. Loans severely past due remain flat versus the prior month at 0.38%. Major industry sectors all showed increases in loans past due. Agriculture and Construction based loans increased 0.05% over the prior month. Retail loan past dues rose 0.03% and Health Care rose 0.01%.

PayNet’s Small Business Delinquency Index (SBDI) which measures loans over 90 days past due rose 0.01% over the prior quarter to 0.38%. Notable increases included Transportation (+6bp M/M), Agriculture (+5bp M/M), Construction (+4bp M/M), and Retail (+3bp M/M).

While credit risk has remained benign for the last several years, this recent report signals a shift to higher levels of credit risk. Credit risk is still subdued, but we note sudden shifts can occur which catch us all by surprise.



Figure 4



Industry Analysis

Borrowing and investment remains up on a year-over-year basis in 12 of the major industry sectors in December. While up in most industry sectors, the major categories are showing a trend to slower expansion. Real Estate Leasing and Rental as well as Manufacturing and Construction reveal negative trendline changes in borrowing and investment over the past three months. Borrowing and investment is contracting in three big industry sectors: Accommodation & Foods (-17.14%), Professional Services (-1.36%) and Wholesale Trade (-0.62%).

Industry YOY Change

Regional Analysis

The good news is that the Top 10 most populous states are all still showing increased borrowing and investment by private companies. While still showing positive results, NC, GA and OH show a recent trendline that indicates contraction by private businesses.

State YoY Change

The trend towards slower growth and outright contraction is evident in several of the largest 10 states.


Credit Risk Outlook

Industry Segment


The slowdown seen in the major industry sectors means this small business lending slowdown is a hit to the real economy. On the bright side, borrowing and investment resumed for small business in January and the financial health of Main Street remains strong. But confidence is fickle, and this report signals a downshift in Main Street business optimism — which we suspect will impact GDP in the next quarter. This remains a substantial shift that although subtle now, presents long-term implications for lenders through higher credit costs. Our AbsolutePD is picking up these signals with forecasted defaults rising to 2.2% in 2019. The boom of 2018 is on track no longer and will likely pass into a slower pace of expansion at slightly rising risk.