Strategic Insights December 2019

12/5/2019
Small Business Credit, Commercial Credit, PayNet Strategic Insights

Small Business Lending Stuck In Neutral

Index Analysis

The PayNet Small Business Lending Index (SBLI) improved 7.7 points (5.5%) to 147.5 in October. On an annual basis, the SBLI ticked down -0.1%, while the SBLI 3-month moving average ticked down on both an annual (-0.4%) and monthly (-0.6%) basis.

Regional Story: Lending activity was mostly flat across the ten largest states in October, with by North Carolina (+0.7% M/M) experiencing the strongest growth and reaching a new all-time high. However, Illinois (-1.9% M/M) and Pennsylvania (-0.7% M/M) both saw modest declines. On an annual basis, Pennsylvania (+3.9% Y/Y) and North Carolina (+2.3% Y/Y) continue to be the strongest performers among large states while Michigan (-5.7% Y/Y) and Illinois (-5.0% Y/Y) experienced moderate contractions.

Industry Story: Industry lending activity was mixed in October. On the positive side, Construction (+0.6% M/M) improved to its strongest reading since 2007 and Health Care (+1.1% M/M) expanded for a 7th straight month. Conversely, Information (-1.6% M/M) fell to its lowest reading ever and Wholesale Trade (-0.7% M/M) slipped to a three-year low. Compared to a year ago, lending activity fell in 11 of 18 industries, including Manufacturing (-4.1% Y/Y), which has declined for 8 consecutive months, and Transportation and Warehousing (-1.4% Y/Y). Health Care (+6.8% Y/Y) and Construction (+1.6% Y/Y) maintained healthy growth rates.

Economic Context

While small business lending activity remained generally healthy in October, the near-term outlook for small businesses remains cloudy. The manufacturing sector continues to struggle: the ISM manufacturing purchasing managers’ index (PMI) fell again in November and has signaled contraction for four consecutive months, while new orders for non-military durable goods edged up just 0.1% in October after falling 1.8% in September. However, while the manufacturing slowdown has affected the broader U.S. economy — Q3 GDP growth slowed to 2.1% in part due to the second consecutive quarter of contracting business investment — the larger service sector has shown resilience thus far, and the non-manufacturing PMI continues to signal expansion (though it also weakened in November). As a result, small businesses remain confident: in addition to the elevated SBLI, the NFIB Small Business Optimism Index improved modestly in October, while the CNBC/SurveyMonkey Small Business Confidence Index also ticked up in Q4. Trade policy will be a key factor to watch in the coming months, as hopes that tensions with China and other key partners would ease have faded somewhat, adding more uncertainty to an already murky 2020 growth picture.

Labor and Trade Costs Rise, but Small Business Finances Remain Sound

Index Analysis

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due held steady in October following fourth consecutive monthly increases and is up 19 basis points over the last 12 months. The SBDI 91–180 Days Past Due was also unchanged and sits 5 bp above its year-ago level.

Regional Story: Three of the ten largest states saw delinquencies rise in October, led by Georgia (+18bp M/M) and Florida (+6bp M/M), while delinquencies fell in Pennsylvania (-7bp M/M) and Michigan (-6bp M/M). On an annual basis, delinquencies rose in all ten large states, with Illinois (+48bp Y/Y) and Florida (+32bp Y/Y) experiencing the sharpest increases. After rising 1 bp in October, U.S. default rates are now at their highest level since May 2012, with a particularly sharp increase occurring in Michigan (+11bp M/M; +38bp Y/Y).

Industry Story: Delinquencies were mostly unchanged across major industries in October, though Transportation delinquencies (+5bp M/M) are now at their highest level since mid-2011. Measured on an annual basis, all major industries saw delinquencies rise, led by Transportation (+84bp Y/Y) and Retail (+29bp Y/Y). Regarding defaults, Manufacturing (+3bp M/M; +44bp Y/Y) and Retail (+3bp M/M; +51bp Y/Y) are experiencing their highest default levels since early 2012. However, nearly all industries are near or below their historical averages, including Mining (-16 bp M/M; -47bp Y/Y) and Information (-16bp M/M; -51 bp Y/Y).

Economic Context

Although PayNet’s delinquency and default indices remain near their long-term averages, Main Street financial stress continues to slowly rise. One oft-cited concern is rising labor costs: NFIB reported in October that “finding qualified labor” is the top business problem of 25% of surveyed small business owners, and the percentage of owners reporting higher worker compensation is historically high. Another concern is the trade war: while small businesses are less likely to be directly affected by tariffs because they are less dependent on global markets, they are often part of the supply chain for large international firms and are thus exposed indirectly. According to recent reports in Axios, CNBC, and the Wall Street Journal, some large firms are attempting to insulate their customers (and their own profit margins) from the impact of tariffs by refusing to accept tariff-driven cost increases from their small business suppliers — a development worth monitoring. However, the Kansas City Fed Financial Stress Index fell in October to its lowest level in over a year, while the St. Louis Fed Index fell in November and remains near historic lows, driven down by lower borrowing costs. Overall, Main Street financial stress continues to slowly rise, but should remain manageable for the foreseeable future.