Strategic Insights October 2019

Small Businesses Losing Steam

Index Analysis

The PayNet Small Business Lending Index (SBLI) fell 8 points to 142.2 in August and is down 5.5% compared to a year ago. The SBLI 3-month moving average also fell and is now below its year-ago level for the first time in more than two years. Despite the decline, the SBLI is still in the top 10% of historical readings.

Regional Story: Eight of the ten largest states saw lending contract in August compared to last month, including steep drops in Michigan (-1.3% M/M), Illinois (-1.2% M/M), and Florida (-1.1% M/M). North Carolina (+0.3% M/M) and Ohio (+0.2% M/M) experienced tepid lending growth. On an annual basis, eight of the ten largest states saw lending contract or stagnate, led by Michigan (-3.6% Y/Y). Pennsylvania had the strongest performance among large states (+5.4% Y/Y), but this growth rate was still the state’s slowest in more than a year.

Industry Story: Lending declined in August across most major industries. Information (-1.3% M/M) dropped to a new historic low, while Professional Services (-0.9% M/M) fell to a six-year low and Manufacturing (-1.1% M/M) fell to a five-year low. On the positive side, Health Care (+0.5% M/M) rose to its highest level since mid-2016. Most industries also experienced lower lending on a year-over-year basis, including double-digit declines in Information (-11.1% Y/Y) and Public Administration (-10.9% Y/Y). Notably, Construction (-0.04% Y/Y) saw its first annual decline since late 2010.

Economic Context

A series of economic headwinds — including a weakening industrial sector, ongoing trade tensions, and softening business investment — are creating an increasingly uncertain operating environment for small business. U.S. manufacturers continue to sound alarm bells: the IHS Markit manufacturing index is barely above its expansion threshold, while the ISM manufacturing index is contraction territory after falling to its lowest level since June 2009 — a particularly notable occurrence given that the ISM was at a 14-year high just 12 months ago. Meanwhile, cooling business investment and a slowing global economy led economists to further downgrade their Q3 growth expectations. The key bright spot for the U.S. economy, however, is also its largest component: consumer spending remains strong despite ongoing trade conflicts, which is helping to shore up Main Street businesses. Measures of consumer optimism are trending downward overall but remain healthy by historical standards, and most market watchers expect another strong holiday shopping season. A pillar of small business health, sustained consumer activity will be a key metric to watch over the remainder of the year.

Financial Stress Builds as Labor Costs Rise

Index Analysis

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due ticked up 2 basis points in August, reaching its highest point since late 2011 and now stands 19bp above year-ago levels. The SBDI 91–180 Days Past Due was unchanged for the third consecutive month in August but is up 4bp on an annual basis.

Regional Story: Six of the ten largest states saw delinquency levels rise in August compared to July, including Illinois (+6bp M/M), where delinquencies have climbed for ten consecutive months and are now at their highest level since late 2011. On an annual basis, most large states saw delinquencies rise, including North Carolina (33bp Y/Y) and Ohio (+18bp Y/Y), which each hit new multi-year highs. Defaults also rose in most large states on an annual basis, hitting their highest point since 2012 in Georgia, North Carolina, and Ohio.

Industry Story: All major industries saw delinquencies rise in August compared to last month, with most reaching multi-year highs. Higher delinquency rates were particularly notable in key sectors like Health Care (+6bp M/M), Retail (+6bp M/M), and Transportation (+4bp M/M). All major industries also saw delinquencies rise in August on an annual basis, including Transportation (+75bp Y/Y), Retail (+31bp Y/Y), and Construction (+21bp Y/Y). Most industries also saw defaults tick up year-over-year, with the Construction default rate (+2.38%; +32bp Y/Y) reaching a nearly 7-year high.

Economic Context

Financial stress continues to rise on Main Street, but small businesses appear well-positioned to manage this challenge. One source of this pressure is the rising cost of labor: the National Federation of Independent Businesses reported in August that the share of small business owners reporting difficulty hiring qualified workers is at an all-time high, and as small businesses compete for increasingly scarce talent, labor costs rise. In addition, the uncertainty and increased costs associated with tariffs are also driving up costs for small business owners. The WSJ/Vistage Small Business CEO Confidence Index survey found that nearly half of small business owners anticipate that new tariffs would have a negative effect on their operations, suggesting that if the trade war with China worsens, small businesses are likely to see financial stress worsen. Overall, however, financial stress remains relatively low by most measures when viewed through a historical lens, including the PayNet SBDI and SBDFI. Moreover, recent reductions to the federal funds rate should lower borrowing costs and help small business owners weather the current industrial sector slowdown.