MANY ECONOMISTS ARE saying this economy is recovering at half-speed. Clearly, publicly held corporations, one half of the economy, have recovered. Their balance sheets carry cash at levels not seen since the 1960s. Stock prices indicate strong valuations and earnings are at healthy levels. The other half of the economy, the small-business sector, remains a mystery. Monthly surveys such as that of the National Federation of Independent Business seem to indicate recession territory, but the lack of financial statements or stock market trading in small business makes it hard to be sure.
The purpose of this article is to shed light on the small-business economy by learning from small businesses' habits and tendencies as illustrated by quantifiable data. Data-driven analysis helps those making loan decisions better understand the risks and the opportunities involved in granting credit to small businesses. This improved understanding can lower the cost of doing business for credit grantors and may enable additional credit to flow more freely to small businesses, thus helping American commerce grow faster.
Another aim here is to assist those who hold portfolios of small-business credits to safely manage their exposures. Long-term defaults move within a range for asset classes, and the small-business asset class is no exception.
Lastly, small, privately held businesses represent a large and diverse mass of credit, which currently sits on the balance sheets of banks, finance companies, and trade financing companies. Increasing the transparency of risk and reward can unlock capital markets and help lenders become an intermediary of small-business credit. The captive finance company that is overly concentrated in farm equipment loans may someday find ways to diversify this over-concentration. In doing so, the sources of credit for small business will expand, and the safety and soundness of the financial system will improve.
An American Hero
The small business owner has encountered challenges during the last recession in the form of weak sales as the U.S. consumer deleverages personal balance sheets and consumer tastes change. While the recent crisis dampened financial activity across the entire globe, the data reveals that small businesses reacted by right-sizing costs and putting their financial houses in order.
Small-business sizing is notoriously difficult. Ask three bankers for a definition of small business and you will get three different answers. This confusion owes to the lack of transparency regarding the financial picture of a small business. Publicly available information on small businesses, such as annual revenues or number of employees, relies on estimates rather than hard data. In an ideal world, the financial statements of small businesses would be readily available, just like the financial statements of public corporations.
In the absence of financial statements, for purposes of this study, PayNet defines a small business to be one with $1 million or less in total loans outstanding. Loans outstanding represent one of the best measures of business size, as they are objectively reported by a third party, the lender, as opposed to being self-reported or estimated.
A cross section of U.S. small businesses serves as the sample for this study. This sample, extracted from PayNet's proprietary database, reflects the geographic and industry makeup of the small-business economy in the United States. PayNet's database encompasses information on more than $800 billion of financial activity by millions of U.S. small businesses and is updated with real-time information each month. Through state-of-the-art analytics, this real-time data is converted into market intelligence and predictive tools that can be used to lower the cost of credit granting and loan management.
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Summary statistics on this sample show the average loan amount to be just under $60,000. …