Strategic Insights November 2019

Commercial Credit, Small Business Credit

Small Business Growth Prospects Remain Cloudy

Index Analysis

The PayNet Small Business Lending Index (SBLI) fell 3.3 points to 139.4 in September but remains in the top 15% of historical readings. Compared to a year ago, the SBLI is up 4.7%. The SBLI 3-month moving average ticked up on both an annual (+1.0%) and monthly (+0.5%) basis.

Regional Story: Six of the ten largest states saw lending activity improve in September, including North Carolina (+1.6% M/M) and Pennsylvania (+1.2% M/M), which each reached all-time highs, and Ohio (0.5% M/M), which recorded its strongest reading since 2007. Pennsylvania (+7.5% Y/Y) and North Carolina (+2.4% Y/Y) also exhibited the strongest performance among large states when measured on an annual basis, while Michigan (-3.5% Y/Y) and Florida (-2.1% Y/Y) recorded sharp annual declines.

Industry Story: Compared to last month, lending activity improved in most industries in September, with Real Estate (+2.3% M/M) and Construction (+0.7% M/M) posting their best index reading in more than a decade. However, Transportation (-1.0% M/M) fell for the fifth consecutive month, while Professional Services (-0.4% M/M) remained at a six-year low. On an annual basis, lending declined in 10 of 18 industries, including Accommodation and Food Service (-9.9% Y/Y) and Professional Services (-1.5% Y/Y), which fell for the 19th and 40th consecutive months, respectively. More positively, Health Care (+6.0% Y/Y) expanded for the 19th consecutive month.

Economic Context

In recent months, the operating environment for U.S. small businesses has weakened, and preliminary data for Q3 growth did little to assuage these concerns. The economy expanded at a pedestrian 1.9% in Q3, with growth driven almost entirely by moderate gains in consumer spending. Business investment contracted for the second consecutive quarter, including a nearly 4% decline in equipment investment, the sharpest since mid-2016. One notable bright spot was residential investment, which expanded for the first time since late 2017. Looking ahead, the economic climate for small businesses remains cloudy. On the plus side, small business optimism is still elevated by historical standards, mirroring solid consumer optimism readings. However, the ISM U.S. manufacturing purchasing managers’ index (PMI) has signaled contraction for three months while the ISM non-manufacturing PMI fell sharply last month, suggesting that manufacturing weakness is bleeding into the broader economy. In addition to consumer spending, another factor to watch in the weeks ahead is trade: the latest CNBC/SurveyMonkey Small Business Survey shows that twice as many small business owners expect a negative impact vs. a positive impact from trade policy and most are nervous about further escalation with China.

Financial Stress Continues its Slow Climb, but Remains Manageable

Index Analysis

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due ticked up 1 basis point in September, its fourth straight monthly increase and highest point since late 2011. The SBDI 91–180 Days Past Due also increased 1 basis point in September and is now up 5 basis points year-over-year.

Regional Story: Of the ten largest states, eight experienced rising delinquency rates in September, led by Florida (+19bp M/M) and Michigan (+13bp M/M), while delinquency rates in Texas (+4bp M/M) and Illinois (+1bp M/M) reached their highest level since 2011. Measured on a year-over-year basis, delinquency trends were similar, with Illinois (+44bp Y/Y) and North Carolina (+31bp Y/Y) experience the sharpest increases. Regarding defaults, rates rose on an annual basis in nine of the ten largest states, with the lone exception being Pennsylvania (-2bp Y/Y).

Industry Story: Among major industries, Transportation (+7bp M/M) and Retail (+5bp M/M) experienced the sharpest monthly rise in delinquency, while Construction (-1bp M/M) was the only major industry in which delinquency declined. Delinquency rates remain at their highest levels since 2011 in most major industries. Measured on an annual basis, Transportation (+80bp Y/Y) and Health Care (+21bp Y/Y) continue to see delinquencies accelerate. Regarding defaults, Transportation (+15bp M/M; +100bp Y/Y) experienced the sharpest increase, though defaults remain below historical averages in most industries, with the notable exception of Agriculture.

Economic Context

Financial stress among U.S. small businesses continued to slowly rise in September, driven in part by rising cost pressures associated with a tight labor market and rising wages. The latest government data show that wages grew at a solid 3% Y/Y clip in October, but the IHS Markit Employment Watch reported an even faster 4% growth rate in annualized hourly earnings. The uncertain economic environment — particularly heightened trade tensions with China and other key partners — is also driving up costs for small business owners, and if the trade war with China worsens, small businesses are likely to experience more financial stress. Despite these headwinds, however, the Kansas City and St. Louis Fed Financial Stress Indices fell in September and remain subdued, and the recently announced 25bp cut to the federal funds rate — the third cut this year after four rate hikes in 2018 — should reduce borrowing costs and put downward pressure on financial stress in the months ahead. Overall, Main Street appears to be well-positioned to manage its debt obligations for the foreseeable future, even as the economy slows.