Strategic Insights September 2020

Commercial Credit, Small Business Credit

Lending Rebound Continues, but Main Street Remains At Risk

Index Analysis

The PayNet Small Business Lending Index (SBLI) continued to bounce back in July after bottoming out in April, increasing 7.1 points (+5.1%) to 147.0. This represents its highest reading since January, and it is now just 2.3% below its year-ago level. The SBLI 3-month moving average increased 10% and is currently 9.6% below its July 2019 level.

Regional Story: Small business lending grew in five of the ten largest states in July, led by Illinois (+0.9% M/M), Florida (+0.6% M/M), and Michigan (+0.5% M/M). Lending fell in Pennsylvania (-1.0% M/M), Texas (-0.4% M/M), and New York (-0.3% M/M), which hit a five-year low. Meanwhile, lending contracted on a year-on-year basis in all ten of the largest states for the fourth straight month. The biggest decreases occurred in Pennsylvania (-10.3% Y/Y), New York (-8.5% Y/Y), and Illinois (-8.1% Y/Y), with Michigan (-1.3% Y/Y) the closest state to returning to year-on-year growth.

Industry Story: Lending activity improved in five of 18 industries in June, including Public Administration (+0.6% M/M) and Construction (+1.3% M/M; highest reading since October 2007). In contrast, Mining, Oil & Gas (-5.2% M/M) and Educational Services (-5.4% M/M; largest-ever monthly decline) fell sharply. On an annual basis, Public Administration (+8.6% Y/Y) and Construction (+7.2% Y/Y) remain the only green shoots, as Mining (-13.2% Y/Y), Wholesale Trade (-8.8% Y/Y), Accommodations and Food Services (-13.6% Y/Y), Professional Services (-8.2% Y/Y), and Information (-7.8% Y/Y) are all in the bottom 20% of their historical readings.

Economic Context

In July, the SBLI improved convincingly for the second month in a row, demonstrating the resilience of small business lending even as the pandemic continues and many small businesses operate at less-than-full capacity. For some firms, investment levels bounced back over the summer as the economy reopened, including in the manufacturing sector. However, while the headline index is strong, there are reasons for concern. According to a recent NFIB survey, while some small businesses have seen sales fully recover, half report that sales are less than 75% of pre-pandemic levels. Other data corroborate these findings: per Womply, the share of small businesses open as of mid-August was 19% below January 2020 levels after declining steadily since early July. Given these trends, it is unsurprising that NFIB reports that 21% of small businesses expect to close in the next six months if economic conditions don't improve. The impact on minority-owned businesses is particularly acute: an August Fed Small Business Report found Black-owned firms have been almost twice as likely to close as small firms overall. While the near-term trajectory of the pandemic — and, by extension, the U.S. economy — is highly uncertainty, what is clear is that current economic distress is being experienced disproportionately, and a significant share of Main Street businesses are at particular risk. As such, while the SBLI shows lending activity has largely rebounded, the crisis facing U.S. small businesses remains a pressing concern.

Main Street Defaults Soar

Index Analysis

The PayNet Small Business Delinquency Index (SBDI) 31–90 Days Past Due fell 20 basis points (bp) last month, though it remains 55bp above its year-ago level. The SBDI 91–180 Days Past Due rose 4 bp and is now 23bp above July 2019 levels. Defaults surged 22bp to 3.20% and have increased 90bp since February.

Regional Story: Delinquencies fell in nine of the ten largest states in July with big declines occurring in Florida (-33bp M/M) and Georgia (-33bp M/M), while Illinois (+1bp M/M) experienced a slight uptick. Monthly declines were accompanied by year-on-year increases in all ten of the largest states, led by Illinois (+99bp Y/Y) and Florida (+88bp Y/Y). Meanwhile, defaults also increased in all large states on both a monthly and annual basis, including record sharp increases in New York (+57bp M/M; +228bp Y/Y), California (+36bp M/M; +189bp Y/Y), and Texas (+27bp M/M; +169bp Y/Y).

Industry Story:In July, delinquency rates fell in every major industry, including Construction (-34bp M/M) and Transportation (-36bp M/M), which are now well-below their pre-pandemic baselines. Measured on an annual basis, however, delinquencies remain elevated, particularly for Retail (+121bp Y/Y) and Health Care (+106bp Y/Y). Meanwhile, defaults increased in nearly every major industry, including record-setting spikes in both Accommodations (+74bp M/M; +303bp Y/Y) and Education (+39bp M/M; +116bp Y/Y).

Economic Context

Small business delinquencies declined for the second straight month in July, but concerningly, defaults continued their rapid ascent. The decline in the SBDI is certainly a positive development, though it may reflect loans being reclassified rather than reduced financial stress: the Equipment Leasing and Finance Foundation recently reported that most equipment finance firms are offering deferral plans, and roughly 40% of firms offering deferrals have more than 5% of their portfolios currently under deferral. The takeaway from recent movement in the SBDFI is less ambiguous: small business defaults are rising rapidly. According to NFIB, PPP funding is nearly exhausted (84% of recipients have fully expended their funds) and sales volumes are still at least 25% below pre-pandemic levels for half of small firms. Not surprisingly, these conditions are squeezing certain industries and regions: for example, Accommodations has seen defaults rise 250 bps since February to 6.1%, and the industry's default rate jumped to 11.1% in New York. In turn, surging defaults may point to small business closures: according to NFIB 2% of small businesses are currently closed, while Census Bureau reports 1.1-1.2% of small businesses closed permanently each of the last two weeks. Meanwhile, 1-in-4 small firms anticipate the need for additional financial support over the next six months according to the Census Bureau’s Small Business Market Pulse. With minimal take-up four months into the Federal Reserve’s Main Street Lending Program — just 0.08% of total lending capacity has been tapped — small businesses will continue to struggle to stop the bleeding unless economic conditions quickly improve.