Economic Recovery and the Changing Landscape for U.S. Small Business: Quantifiable Data and Analysis Can Provide Insight into the Financial Heath of Small Businesses, the State of Economic Recovery, Lending Trends, and Risk Forecasts

By Phelan, William | The RMA Journal, November 2010 | Go to article overview

Economic Recovery and the Changing Landscape for U.S. Small Business: Quantifiable Data and Analysis Can Provide Insight into the Financial Heath of Small Businesses, the State of Economic Recovery, Lending Trends, and Risk Forecasts


Phelan, William, The RMA Journal


SMALL BUSINESSES ARE among the most important drivers of U.S. economic growth and have become the centerpiece of the recovery. Although no one knows precisely how much small businesses contribute to the U.S. economy, statistics suggest they represent 50% of gross domestic product, employ 50% of the private workforce, and are the source of most job creation.

The perplexing aspect of the small business economy is not its importance as the engine of U.S. growth, innovation, and competitive edge, but rather how little we know about it. This limited knowledge hinders bankers, the primary providers of capital through loans, lines of credit, and leases.

In a study for The RMA Journal, PayNet, Inc. conducted an extensive analysis of its proprietary database of 17 million commercial and industrial (C&I) loans, totaling $740 billion, made to millions of U.S. small businesses. This study looked at the actual borrowing and risk behaviors of millions of small U.S. companies across SIC categories representing a cross section of industries. By examining borrowing activities and default rates by industry and geographic region, PayNet was able to gather information on the direction of small business sectors. The data focuses on businesses with total C&I exposures of less than $1 million on term loans, commercial equipment leases, and lines of credit.

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Because small businesses generally respond to changes in economic conditions more rapidly than larger businesses, this study uses the Thomson Reuters/PayNet Small Business Lending Index (SBLI), which serves as a leading indicator of the economy, using lending activity from major commercial credit providers across the nation. Research shows that the index leads change in GDP by between two and five months. Small businesses are tracked by 21 primary industries to profile recent borrowing and credit trends.

This study presents loan default rates of small businesses for the top 21 aggregate SIC categories during the 2006-09 period. To measure defaults, we use a definition that considers the status of the entire borrowing relationship between lenders and the borrower, not just loan delinquency.

The study also provides a forward-looking risk forecast by industry and geographic region, estimating the probability that small businesses will default on their loan obligations. This probability is derived from AbsolutePD, a risk forecasting system built by Darrell Duffle of the Stanford Graduate School of Business. AbsolutePD provides estimates of default on individual obligors using their loan payment characteristics in combination with macroeconomic factors. These defauh estimates for millions of business borrowers are then combined at the portfolio, industry, and geographic levels to form a risk outlook for 2010-11.

[FIGURE 1 OMITTED]

Historical Loan Borrowing Activity

The National Bureau of Economic Research (NBER) dates the start of the recent recession at December 2007. The NBER reports that GDP began growing again in the third quarter of 2009, when it expanded 2.2% over the prior year.

A look at the Thomson Reuters/PayNet SBLI reveals a slightly different story. Figure 1 shows that small businesses began to reduce borrowing dramatically as early as the first quarter of 2007, well before the official start of the recession. By December 2007, the official start of the recession, the SBLI had already exhibited several quarters of pullback and was clearly on a trend line indicating recession. The trough of the SBLI occurred in May 2009, when business borrowings shrank more than 30% versus the prior year. Since then, the SBLI has indicated recovery, growing 16% as of June 2010. The index tells us that the small business economy does not necessarily mirror the recovery pattern of larger corporations, at least in this recession.

The upward trend in the SBLI Index over the past year indicates that small companies are starting to borrow and expand again. …

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