Strategic Insights February 2020

2/5/2020
Small Business Credit, Commercial Credit, PayNet Strategic Insights

Main Street Uncertain Heading Into 2020

Index Analysis

The PayNet Small Business Lending Index (SBLI) fell 1.5 points (-1.1%) to 138.6 in December and is up 3.9% above its year-ago level. The SBLI 3-month moving average ticked down on a monthly basis (-0.3%) while increasing slightly relative to a year ago (+0.6%).

Regional Story: Lending activity improved in eight of the ten largest states in December. Pennsylvania (+1.5% M/M), New York (1.3% M/M), and California (+0.9% M/M) led the way, with New York small business lending reaching its highest level since April 2008. Measured on an annual basis, lending picked up in Pennsylvania (+4.1% Y/Y) and New York (+2.8% Y/Y), while Illinois (-7.2% Y/Y) and Florida (-3.0% Y/Y) contracted.  All ten of the largest states are in the top 75th percentile of historical index readings, and three states (NC, PA, and TX) are near all-time highs.

Industry Story: Lending activity improved in the majority of industries in December, with Real Estate (+2.0% M/M) reaching an 11-year high and Health Care (+1.7% M/M) achieving its highest reading ever. Less positively, Agriculture (-2.0% M/M) saw a sharp decline in lending, while Transportation and Warehousing (-0.8% M/M) decreased for an eighth straight month. On a year-ago basis, Construction (+3.5% Y/Y) and Real Estate (+3.5% Y/Y) reached their highest levels since the Great Recession while Professional Services (+0.4% Y/Y) improved for the first time in nearly four years. Information (-12.9% Y/Y), however, fell to a new all-time low.

Economic Context

Small business optimism remains elevated, though worrisome signals continue to build. In some ways, the economy is generally healthy: growth in Q4 was a moderate 2.1%, unemployment remains at multi-decade lows, and consumers continue to drive the U.S. economic engine. However, the economy may not be as strong as the headline growth number suggests. For example, real final sales to private domestic purchasers — a lesser-known proxy for domestic demand — expanded at just 1.4% Q/Q, the slowest pace in four years. Moreover, business investment fell for the third straight quarter (-1.5% Q/Q) — the first time this has occurred since 2009 — while growth in demand for C&I loans is anemic. Nonetheless, the WSJ/Vintage Small Business CEO Confidence Index shows Main Street is cautiously optimistic, posting its first year-over-year gain since September 2018. This improvement could be partially related to hopes that the manufacturing sector may have finally bottomed: the January ISM Manufacturing PMI (50.9) was stronger than expected and now signals modest expansion after six months of sub-50 readings. Unfortunately, major questions remain for the U.S. economy, including the impact of the Chinese coronavirus, which, in addition to its health impacts, could disrupt global supply chains and complicate the Phase 1 trade deal with China. While the prospect of an improving manufacturing sector is a welcome sign, Main Street's outlook is somewhat muted in the near-term.

Financial Pressures Continue to Edge Up, but Remain Manageable

Index Analysis

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due ticked up 1 basis point (bp) in December and is 18bp above its year-ago level. The SBDI 91–180 Days Past Due was unchanged for a second straight month but has risen 5bp over the last twelve months.

Regional Story: In December, delinquencies rose in all ten of the largest states on both a monthly and annual basis. Compared to November, the largest increases occurred in Georgia (+17bp M/M), Pennsylvania (+10bp M/M), and Michigan (+9bp M/M), all three of which rose to 8-year highs. On a year-ago basis, delinquencies increased sharply in Illinois (+48bp Y/Y), Georgia (+39bp Y/Y), and Ohio (+32bp Y/Y). Defaults also rose in the ten largest states, highlighted by an 8-year high in Michigan (+10bp M/M; +41bp Y/Y). However, defaults remain near or below their long-term averages.

Industry Story: Changes in delinquency levels were mixed across major industries in December. Transportation delinquencies (+5bp M/M) increased to its highest reading since May 2011, while Retail delinquencies (-7bp M/M) experienced a moderate decline. Compared to year-ago levels, delinquencies are up across all major industries, though the rate of increase for Agriculture (+3bp Y/Y) and Construction (+6bp Y/Y) has decelerated since last summer. Regarding defaults, Accommodations (+11bp M/M; +69bp Y/Y) and Transportation (+10bp M/M; +180bp Y/Y) reached 8-year highs, while Information (-23bp M/M; -49 bp Y/Y) defaults continue to fall sharply.

Economic Context

Financial stress continues to steadily rise on Main Street, and there is evidence that this trend may continue in 2020. According to the latest Fed Senior Loan Officer Survey, 19% of banks expect loan performance from small firms to deteriorate this year while just 1% expect it to improve. Trade is another headwind for loan performance, as summarized in a recent NYT report highlighting the trade-induced struggles of the transportation industry (a finding consistent with PayNet industry-level data discussed above). It is worth noting, however, that the steady increase in delinquencies and defaults is not surprising given this stage in the business cycle. Moreover, U.S. consumers — the lifeblood of small businesses — are generally in a financially sound position: Black Knight's Mortgage Monitor reported foreclosure rates hit a 14-year low last month, while the Consumer Debt Service Ratio and the St. Louis Fed Financial Stress Index sit at historic lows. Given the relative strength of financial stress indicators in the broader economy, Main Street should be able to weather its slowly mounting financial pressures in the months ahead.