Q2 2019 Credit Outlook for Main Street

Credit Outlook

What's the Frequency, Kenneth?

PayNet’s latest report on credit conditions for Main Street begs this question above, which was originally posed in the now-famous REM Song. While REM posed this question to try to understand what motivates the younger generation, our aim is economic rather than existential: what is causing the rapid swings in loan originations among Main Street businesses, and what does it mean for the rest of the year? In 2018, the frequency was strong, clear, and steady, providing an unmistakable signal of booming growth for small businesses. Earlier this year, the frequency weakened, suggesting a growth slowdown was in the making. PayNet’s latest data suggest that the frequency is strong once again, with the PayNet Small Business Lending Index hitting an all-time high in April.

The “Loud/Soft/Loud” fluctuations are likely indicative of a heightened sense of uncertainty in the US economy this year. Indeed, rising tension between the United States and key trading partners in recent weeks, if unresolved, could negatively affect small business supply chains and reduce small business lending during the second half of the year. All things considered, however, PayNet data suggest that small businesses remain well-positioned for growth this year, even as credit risk continues to tick up.

Business Cycle

This latest release shows small business lending bounced back after slipping last quarter. Figure 1 shows small business lending rose in Q1 versus the prior quarter while credit risk ticked higher for the sixth consecutive quarter. As pointed out above, the growth thus far in 2019 was driven by the large and surprising jump in April. Figure 1 shows 2019 taking the same pattern as 2017 and 2012. In each of those years, Main Street businesses pulled back on borrowing and investing after strong growth in the prior year. If this pattern holds, we can say with some amount of confidence that 2019 is a pause to digest the heavy investments that were made in 2018, which in retrospect was a boom year. This pause remains the most likely explanation given the still low credit risk, which I’ll explain shortly.

Recent Investment Activity

The PayNet Small Business Lending Index (SBLI) rose 20.1 points to an all-time high of 159.7 in April and is now up 11.4% compared to year-ago levels. The SBLI 3-month moving average also rose on a monthly basis and currently stands 3.2% above its year-ago level.

As a result, the SBLI ends the first part of this year recovering all the investment gains wiped out in the first few months of 2019.

Industry Story

On a monthly basis, lending expanded in the majority of industries in April, led by Mining, Quarrying, and Oil and Gas Extraction (+4.5% M/M), Healthcare and Social Assistance (+1.4% M/M), Construction (+1.3% M/M), and Wholesale Trade (+1.3% M/M). Lending in other industries contracted, including Finance and Insurance (-1.1% M/M) and Accommodation and Food Services (-0.9% M/M), which is now at a 6-year low. Compared to year-ago levels, ten industries saw lending expand, led by a double-digit increase in Transportation and Warehousing (+13.7% Y/Y). Manufacturing (-0.4% Y/Y) slipped on an annual basis for the second consecutive month. 

Regional Story

In April, lending rose on a monthly basis in each of the ten largest states, including notable increases in Ohio (+2.2% M/M), North Carolina (+1.6% M/M), and New York (+1.3% M/M). Three states — Illinois (+0.9% M/M), Pennsylvania (+1.2% M/M), and Texas (+0.8% M/M) — saw the index reach record highs. Similarly, all ten of the largest states saw lending expand compared to a year ago, led by a double-digit increase in Pennsylvania (+12.2% Y/Y).

Credit Risk

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due rose three basis points to 1.52% in April — its sixth consecutive increase and highest point in more than seven years — and is up ten basis points annually. The SBDI 91–180 Days Past Due held at 0.39% for the third straight month but rose two basis points year-over-year.

Industry Story

On a monthly basis, delinquencies increased in most major industries, led by Transportation (+12bp M/M) and Health Care (+6 bp M/M). On an annual basis, all major industries saw delinquencies rise, including double-digit jumps in Transportation (+46 bp Y/Y), Construction (+24 bp Y/Y), and Retail (+14 bp Y/Y), All major industries are now at or above their long-term median reading. Regarding defaults, most industries saw higher default rates compared to twelve months ago, including Mining (+20bp Y/Y) and Manufacturing (+13bp Y/Y), where defaults have increased for three months in a row after falling throughout 2018.

Regional Story

Three of the ten largest states — Illinois (+5bp M/M), North Carolina (+5bp M/M), and Pennsylvania (+5bp M/M) — saw delinquencies increase in April. On an annual basis, delinquencies rose in all ten of the largest states, led by Florida (+26bp Y/Y) and North Carolina (+24bp Y/Y). Despite the uptick, delinquencies remain in the bottom half of historical readings in most large states. Regarding defaults, most large states saw annual increases, with default rates in three states (Georgia, Michigan, and Florida) reaching their highest point since 2012.

With each monthly report we see subtle increases in credit risk. While no single month represents a major increase in delinquencies, the successive slow, almost imperceptible, monthly increases are creating a cumulative effect resulting in higher levels of credit risk. For now, we can say rising delinquencies are not a major concern, but if they continue, we could wake up one day and realize we have a new issue to address.

Credit Risk Outlook

The slow, almost imperceptible, monthly increases in loan delinquencies remain below the long-term average for small business loans. These below average loan delinquencies have generated below average business defaults as we see in Table 1.

However, the rising delinquencies combined with rising interest rates and higher GDP translate into elevated default forecasts of 2.3% in 2019 and 2.5% in 2020. Note these forecasts have risen from 2.2% and 2.5%, which we presented in the last quarterly outlook.


The frequency of this expansion phase has jumped around recently. 2017 was silent mode, 2018 full volume and the start of 2019 low, almost background noise. The latest PayNet release suggests that small businesses lending is resurging after easing earlier in the year. Given the current stage of the business cycle, it is unlikely the party will continue for long, and while the volume might ramp up, the neighbors are likely to tell us to “turn that music down.” No one knows how long the party will continue, but we can say volatility in originations activity each month signals uncertainty on the part of small businesses. That uncertainty combined with slowly rising credit risk bear careful vigilance. We expect defaults to rise even faster than we had originally forecasted to 2.3% in 2019 and 2.5% in 2020.