2016 Q1 Small Business Credit Outlook Risk-Off Keeps the Expansion Intact March confirms the current wait and see mood of private companies. On a macro level, private companies are maintaining current production of their goods and services in industries not directly exposed to the ongoing commodity bust. Micro analysis shows that most industry sectors are reducing investment in production capacity as a sign of their bearish outlook for the economy. At the same time, the finances of private companies remain strong but maybe too strong as loans past due fell again in March. Construction remains the only major sector driving this economy. Private companies just don t want to take on a lot of risk right now, and that won t drive GDP growth near-term.
Business Cycle The reward part of the risk/reward equation took a hard turn south in the 4th quarter of 2015 which thankfully abated in the 1st quarter of 2016. In another encouraging sign, the investment plunge has not been coupled with deteriorating financial health. As a result, we can say that the business cycle has averted an inflection, but the odds of a cycle change have certainly increased. Small businesses sharply curtailed investments to build more, invent new products, or to make their plants or operations more efficient. As can be seen in Figure 1, investment and credit risk found a bottom in the 1st quarter. While the plunge in Q4 was unwelcome, at least we can say that it is not continuing. A cautious reaction would be to stop lending to borrowers, to limit concentrations to segments that are exposed to US consumers, and to start pulling in lines of credit. While caution can be a sound strategy, it can also be costly through missed growth opportunities. Lower investments with steadily low loan delinquencies means that the business cycle phase remains in moderate expansion at low risk. PayNet Small Business Cycle 140 130 1Q07 1Q06 1Q16 1Q15 120 110 CONTRACTION 1Q14 SBLI Originations Index 100 90 80 1Q10 1Q09 RECESSION 1Q08 1Q05 1Q11 RECOVERY 1Q12 1Q13 EXPANSION 70 60 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0% SBDI 91-180 Day Delinquency Index
Recent Investment Activity The Thomson Reuters/PayNet Small Business Lending Index (SBLI) seasonally adjusted originations decreased 3% from 138.9 in February 2016 to 135.3 in March 2016. The small decrease in the Index comes one month after the largest monthly increase in the Index s history in February. Compared to the same month one year ago, the Index is up 4%, however, the rolling three-month Index is essentially flat from February 2016 and is up 3% as compared to the same period one year ago. The rolling three-month Index held steady after five consecutive months of decreases from September 2015 to January 2016. 150 Thomson Reuters/PayNet Small Business Lending Index (SBLI) (January 2005 - March 2016) 140 130 120 110 Index Value 100 90 80 70 60 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Consumer staples sectors show the most expansion by industry segment. Construction (+9.2%), Retail Trade (+6.6%), and Real Estate Services (+5.5%) show the largest year-over-year increase in investment. The lagging sectors continue to be commodity based with Agriculture (-19.0%), Mining & Quarrying (-16.4%), and Wholesale Trade (-3.5%). The striking point is that most industry sectors show investment at a 1 4% range which means that they are in a maintenance mode of replacing worn-out assets rather than undertaking organic expansion. One Year Change in New Originations NAICS Industry Segments March 2016 YoY Change Construction 9.2% Administrative and Support Services 8.4% Retail Trade 6.6% Real Estate and Rental and Leasing 5.4% Finance and Insurance 4.0% Transportation and Warehousing 3.8% Other Services (except Public Administration) 3.7% Manufacturing 3.3% Health Care and Social Assistance 3.2% Arts, Entertainment, and Recreation 2.4% Public Administration 1.7% Professional, Scientific, and Technical Services 1.3% All Industries 1.0% Educational Services 0.7% Accommodation and Food Services -0.3% Information -2.3% Wholesale Trade -3.5% Mining, Quarrying, and Oil & Gas Extraction -16.4% Agriculture, Forestry, Fishing and Hunting -19.0%
Credit Risk What is particularly concerning is that risk taking is not accelerating. The Thomson Reuters/PayNet Small Business Delinquency Index (SBDI) 31-90 days past-due held steady at 1.21% from February 2016 to March 2016. As compared to one year ago, delinquency decreased 3 bps; this is the 10th consecutive month of yearover-year decreases after 12 straight months of increases. Transportation delinquency is up 5 bps to 1.28% - its 13th consecutive month of increase and its highest level since April 2013. Agriculture delinquency is up 3 bps to 0.63% - its sixth consecutive month of increase and its highest level since August 2011. Health Care and General delinquencies each decreased 1 basis point. Loans severely past due increased slightly signaling continued benign credit risk.the Thomson Reuters/ PayNet Small Business Delinquency Index (SBDI) 91-180 days past-due increased 1 bp from 0.26% in February 2016 to 0.27% in March 2016. The Index is up for just the second time in the past 19 months. As compared to one year ago, delinquency is down 8% (2 bps) - the 11th consecutive month of year-over-year declines after 12 months without a decrease. Transportation delinquency increased 1 bp to 0.35% - its seventh consecutive month of increase and highest level since April 2012. Agriculture delinquency increased 1 bp to 0.19% - its fourth consecutive month of increase and highest level since April 2011. Health Care delinquency fell 1 bp and was the only segment to see a decrease. 4% Thomson Reuters/PayNet Small Business Delinquency Index (SBDI) (31-90 Days Past Due) (January 2005 - March 2016) 3.5% 3% 2.5% Index Value 2% 1.5% 1% 0.5% 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Regional Perspective The Southeast and Northeast are currently driving U.S. economic growth. Investment by small business, which is measured by lending activity, has risen the most in Florida (+10.3%), North Carolina (+6.2%), and Georgia (5.3%). Lagging states reflect the systemic problems in the energy and agriculture sectors. Illinois lags the most at -5.2% and Texas follows at -2.6%. Michigan (+4.2%), California (+3.7%), New York (+3.2%), Ohio (+3.1%), and Pennsylvania (+2.4%) show small businesses operating at maintenance levels as opposed to organic expansion. The trend line for the 10 largest states shows 5 increasing and 5 decreasing. PayNet Small Business Delinquency Index by State (31-90 Day) WA ME CA OR NV ID AZ UT MT WY CO NM ND MN SD WI IA NE IL KS MO OK AR MS IN MI TN AL KY OH GA WV PA SC VA NC NY VT NH MA RI CT NJ DE DC MD AK TX LA FL HI < 0.50% 0.50-0.99% 1.00-1.50% > 1.50% Credit risk improved in most of the 10 largest states reflecting restrained investment and a return to lower credit risk. Year-over-year loans 31-180 days past due stand lower in 7 of the 10 largest states. New York (-0.49%), California (-0.25%), and Illinois (-0.26%) display the largest decreases in loans past due. Credit risk has risen the most in Texas (+0.42%) and Michigan (+0.19%), but Texas reflects a batten-down-the-hatches setting while Michigan is one of the few states presently in a risk-on mode. The following table shows 31-180 days past due for the 10 largest states. Delinquency of 10 Largest States (31-180 Days Past Due) State SBDI March 2016 YoY Change New York 1.49% -0.49% Illinois 1.41% -0.26% California 1.29% -0.25% Florida 2.04% -0.08% Georgia 2.02% -0.07% United States 1.47% -0.06% North Carolina 1.55% -0.04% Pennsylvania 1.68% -0.02% Ohio 1.14% 0.02% Michigan 1.39% 0.19% Texas 2.19% 0.42%
Credit Risk Forecast Of note is that risk in the economy remains low reflecting the prevalence of economic restraint. The data show that business defaults are forecasted to reach 2.0% for all of 2016, versus our prediction of 1.9% at the start of the year. Industries that are driving the increase include Transportation +0.9%, Mining +0.7%, Construction +0.6%, and Agriculture +0.8%. Historical And AbsolutePD Forecast Default Rates Industry Segment Actual Historical Default Rates (1) Forecast Default Rates (2) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* 2017 Transportation 4.3% 6.4% 10.1% 12.4% 7.8% 4.2% 2.8% 2.7% 2.5% 2.7% 3.8% 3.0% Information 3.5% 4.4% 4.9% 6.7% 3.6% 3.5% 2.9% 2.4% 2.2% 2.3% 2.3% 2.1% Mining 1.0% 2.6% 3.5% 6.8% 4.8% 2.1% 1.8% 1.2% 1.3% 2.3% 3.0% 2.3% Retail 2.5% 3.2% 4.4% 6.3% 4.3% 2.5% 1.9% 1.7% 2.1% 1.9% 2.0% 2.1% Construction 2.7% 4.3% 6.7% 10.5% 7.5% 3.7% 2.2% 1.7% 1.6% 1.9% 2.5% 2.4% Accommodation and Food 4.0% 5.1% 6.8% 7.7% 6.0% 3.2% 1.7% 2.0% 1.6% 1.8% 2.1% 2.6% Health Care 2.5% 3.0% 3.7% 4.2% 3.5% 2.1% 2.0% 1.9% 1.8% 1.8% 1.9% 2.0% Professional Services 2.7% 3.5% 4.3% 5.3% 3.5% 2.4% 1.9% 1.7% 1.6% 1.7% 2.0% 1.8% Administrative Services 2.4% 3.1% 4.3% 6.1% 4.5% 2.7% 2.1% 1.9% 1.8% 1.6% 2.1% 1.9% Manufacturing 2.1% 2.4% 3.3% 5.8% 4.1% 2.3% 1.6% 1.3% 1.5% 1.6% 1.8% 1.7% Agriculture 2.0% 1.8% 1.8% 2.7% 2.3% 1.5% 0.9% 0.8% 0.9% 1.4% 2.2% 1.8% Wholesale 1.9% 2.1% 3.0% 4.2% 3.2% 1.9% 1.2% 1.1% 1.2% 1.3% 1.6% 1.8% Other Services 2.4% 2.7% 3.9% 4.8% 3.1% 2.1% 1.6% 1.3% 1.2% 1.3% 1.8% 1.8% Finance 3.5% 7.5% 7.1% 5.8% 3.5% 2.0% 2.0% 1.4% 1.1% 1.3% 1.7% 1.6% Entertainment 3.3% 3.7% 4.2% 4.2% 2.7% 2.3% 1.7% 1.3% 1.1% 1.0% 1.8% 2.1% Education 2.4% 2.5% 2.8% 2.9% 2.0% 1.4% 1.4% 0.9% 1.1% 1.0% 1.6% 1.9% Real Estate 2.1% 3.2% 5.0% 6.6% 4.1% 2.5% 1.4% 1.3% 1.2% 1.0% 1.8% 1.8% Public Administration 2.5% 2.8% 1.9% 2.4% 1.6% 1.5% 2.0% 1.2% 0.9% 0.6% 1.6% 1.9% ALL INDUSTRIES 2.6% 3.6% 4.8% 6.2% 4.2% 2.5% 1.8% 1.6% 1.5% 1.6% 2.0% 1.9% Source: (1) PayNet Small Business Default Index (2) PayNet AbsolutePD $1.0mm or Less in Total Lease/Loan Exposure *2016 Forecasts Include 1 Quarter of Actual Defaults
Summary A risk-off scenario isn t good for investment and will likely restrain GDP growth this quarter. However, risk-off reduces chances of imbalances and over-investment and creates favorable conditions for future growth. Improved credit risk positions businesses to accelerate their investments beyond the 3% rate that we see now. Once political, economic, and geopolitical uncertainties become clearer, small businesses are poised to once again become a driver of GDP growth given the favorable financial picture and outlook for the US consumer. In a risk-off climate, GDP will remain moderate and below its long-term potential. Credit quality, measured in terms of default rates, is forecast to register 2.0%. This is still well below prerecession default rates rendering a good sign for lenders.
About PayNet, Inc. PayNet is the leading provider of credit ratings on small businesses enabling lenders to achieve optimal risk management, growth, and operational efficiencies. PayNet maintains the largest proprietary database of small business loans, leases, and lines of credit encompassing over 23 Million contracts worth more than $1.3 Trillion. Using state-of-the-art analytics, PayNet converts raw data into real-time marketing intelligence and predictive information that subscribing lenders use to make informed small business financial decisions and improve their business strategy. PayNet s small business capabilities range from historic credit-reporting and automated credit-scoring to detailed strategic business reviews that include portfolio risk measurement, default forecasting, peer benchmarking, and critical industry trend analysis. PayNet Contact Information PayNet, Inc. 5750 Old Orchard Rd., Suite 300 Skokie, IL 60077 866-825-3400 www.paynetonline.com William Phelan President 866-825-3400 bphelan@paynetonline.com www.paynetonline.com PayNet Risk Insight Suite www.sbinsights.net PayNet, PayNet AbsolutePD, and PayNet Risk Insight Suite are registered trademarks of PayNet, Inc. 2016 PayNet, Inc. Taking the Risk Out of Small Business Lending For more information please call (866) 825-3400 or visit sbinsights.net