Q3 2014 Experian/Moody's Analytics Small Business Credit Index

Q3 2014Q3 2014

Q3 2014

Experian/Moody’s Analytics Small Business Credit Index


Table of ContentsExecutive summary 2

Experian/Moody’s Analytics Small Business Credit Index 3

Behind the numbers 4

Recent performance 4

Construction industry in flux 6

Growing concerns about agriculture 6

Looking ahead 7

1


Small Business Credit Index reaches all-time high in 2014 Q3

Executive summaryThe Experian/Moody’s Analytics Small Business Credit Index (SBCI) gained 2 points to reach 114.8 from a revised 112.8 in the second quarter (previously reported as 112.2). The index measures credit conditions for firms with fewer than 100 workers, and last quarter’s move puts it at an all-time high. This is the second consecutive quarterly gain for the index after harsh winter weather pushed it lower in the first three months of this year and provides compelling evidence that the small-business landscape continues to improve.

Credit balances and the number of trades each expanded in the third quarter, contributing to the rise in the SBCI. This was accompanied by a decline in the delinquency rate to a cyclical low of 8.8 percent. Additionally, job growth continued at a brisk clip last quarter, further supporting the topline index value.

The threat of a global economic slowdown has intensified in recent weeks, leading to gyrations in financial markets. A weaker German economy is raising some alarms, and a triple-dip European recession could hurt small companies, particularly in the northeastern part of the country. Further, households may go back on the defensive if financial markets lose too much ground, eroding at least some of the gains in consumer confidence over the past couple of months. This could be amplified by fears of a potential Ebola outbreak.

Consumer sentiment has been a bit tougher to gauge over the past couple of months. Despite falling more than anticipated in September, the Conference Board consumer confidence index is still near seven-year highs reached earlier in the year. The University of Michigan Consumer Sentiment Index logged its strongest reading since July 2007 in October as shoppers indicated brighter views of the economic outlook. Additionally, assessments of current household finances are trending at recovery highs amid stronger hiring and lower unemployment, gasoline prices and borrowing costs. At least some of this additional expendable cash could make its way to small businesses, meaning additional short-term improvements are likely.

However, higher-frequency measures such as the Rasmussen Consumer Index and the Bloomberg Consumer Comfort Index sank quickly in recent weeks and are struggling to reclaim lost ground, calling into question the strength in the University of Michigan and Conference Board measures.

However, the positives still seem to outweigh the negatives. Moody’s Analytics expects Gross Domestic Product (GDP) growth to remain north of 3 percent through 2015, and the United States should be back to full employment by the end of 2016. Average earnings will rise as the labor market tightens. This will go a long way in boosting consumer sentiment and spending, which will ultimately support small-business balance sheets.

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Current quarter (2014 Q3): 114.8 Previous quarter (2012 Q4): 112.8

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4

Behind the numbers

Several key factors lifted the Experian/Moody’s Analytics Small Business Credit Index in the third quarter. Outstanding credit balances grew by 4.9 percent annualized and are up 1.9 percent from a year ago. This marks a noticeable acceleration from earlier in the recovery and reinforces the notion that the small-business credit spigot is reopening after years of difficulty obtaining credit.

Not only are credit balances growing, but the share being paid late fell to 8.8 percent last quarter, the lowest rate since data tracking began (see Chart 1). This represents a 0.5 percentage point drop from 9.3 percent in the second quarter and is the second steepest quarterly decline in the index’s history.

The drop was led by a 0.7 percentage point decline in severely delinquent balances — those that are more than 99 days past due (see Chart 2). It is impossible to distinguish between severely delinquent balances that are being paid in a more timely fashion and charge-offs by lenders, both of which would lower the delinquency rate for balances in that bucket. Yet the 4.4 percent annualized rise in the number of tradelines would suggest that lenders are not closing accounts for nonpayment. Instead, it appears small businesses in most industries are paying down their arrears.

Recent performance

Following the harsh winter months in the first quarter of 2014, small businesses continued to see a significant rebound in Q3. According to recent business credit data from Experian, businesses have improved their payment behavior,

reducing the number of days they paid their bills beyond contracted terms by more than a day or nearly 19 percent from a year ago. Additionally, over the same time period the data showed that the average commercial risk score went up 4.5 percent, going from 58 to 60.6. Bankruptcy rates also showed significant improvement with 11.9 percent fewer businesses filing.

Despite improving credit conditions, broader small-business performance metrics still suggest some headwinds are preventing a stronger recovery for small companies. For instance, the Small Business Survey conducted by the National Federation of Independent Businesses was a mixed bag in September. Fewer respondents indicated they plan to make capital expenditures, and a smaller share have open job positions to be filled.

Yet other details weren’t all that bad. The largest share of firms since December 2007 indicated they think now is a good time to expand, and plans to raise compensation are still trending at recovery highs.

Like consumers, Main Street businesses are most likely learning to trust in the staying power of the recovery. The past five years have been riddled with false starts, and 2014 feels like the first year in which a natural disaster or gridlock in Washington has not curtailed the recovery. Therefore, it may be somewhat natural at this point for small companies to question whether the economy has really hit its stride and is on its way back to expansion (see Chart 3).

Some of the pullback in small-business sentiment is probably fundamental as well. Some of September’s weakness

could reflect August’s weak jobs report. The associated slowdown in labor income in August likely hit September sales, which is evident in the National Federation of Independent Business (NFIB) report. If so, the index could pull higher again in October.

Small-business employment data have been mixed as well. Companies with fewer than 20 workers added approximately 10,000 jobs in September, according to data from payroll processor Intuit. The build comes on the heels of a flat month in August. Despite the increase in employment, worker compensation and hours worked edged lower, though this is partly because of payback after gains in the previous month. On the bright side, revenues continued to grow, led by gains in real estate, rental, leasing and construction companies.

For the most part, small business across most industries are faring better than they have in years (see Charts 4 and 5). However, construction could still face some challenges even as the housing recovery continues to gain momentum, and small agriculture-related firms may suffer from a steep drop in crop prices over the past year.

Credit quality for manufacturing and trade firms backslid, which is an indication that slower global growth may be hurting industry revenues. Therefore, it will bear watching if credit quality deteriorates further in the next couple of quarters if global growth does not pick back up, especially given the risks to Europe’s near-term outlook brought on by a dearth of private business investment.


5

Sources: Experian, Moody’s Analytics

Outstanding credit, % change year ago Delinquency rate %

8.8

9.0

9.2

9.4

9.6

9.8

10.0

10.2

10.4

10.6

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

14Q2 14Q313Q1 13Q2 13Q3 13Q4 14Q1

Chart 1: Delinquency Rate Hits Recovery Low… Firms with fewer than 100 workers

Chart 2: …Led Largely by Severe DelinquenciesPercentage point contribution to change in delinquency rate


-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

12 13 1499+ days 90-day 60-day 30-day Total

Chart 3: Firms Second-Guess the Recovery

Sources: Experian, Moody’s Analytics, NFIB

85

87

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97

949698

100102104106108110112114116

10 11 12 13 14

Japanesetsunami Fiscal cliff

Government’s shutdown

?

Experian/Moody's Analytics SBCI, 2011Q1=100 (L)

NFIB Small Business Optimism Index, 1986=100 (R)

Chart 4: Delinquency Down For Most Industries

-1.5 -1 -0.5 0 0.5 1

Transportation

Construction

Agriculture

Other

General Services

Finance

Administrative

Trade

Manufacturing

Percentage point change in delinquency rate from 2014Q2


16 186 8 10 12 14

Finance

Agriculture

Other

General Services

Trade

Manufacturing

Construction

Administrative

Transportation

Chart 5: Few Changes in Rank Order From Q2Share of past-due balances, percentage, 2014Q3



6

Construction industry in flux

The share of past-due balances owed by small construction companies fell to 13 percent in the third quarter. This is still above the 8.8 percent average for all industries, but the rate is 1 percentage point lower than in the second quarter and 10.3 percentage points below the peak reached in December 2010 in the throes of the recession.

Unfortunately, the news may not all be good here. The drop in total delinquency was led solely by a steep decline in severely delinquent balances, accompanied by fewer tradelines and a nearly 1.5 percent decline in the volume of balances. This suggests that at least some of the severely delinquent accounts in the industry may have been closed, marking a difference between the construction industry and most others.

This is a setback to an industry that has struggled more than most to recover from the recession, and the future may still present some problems. The housing recovery has become more broad-based regionally, but there are still pockets of the country where weakness abounds. In particular, the housing markets in parts of New England, including much of upstate New York and Maine, are exhibiting few, if any, signs of improvement, as well as several states in the South, namely Louisiana, Mississippi and Alabama. Areas of the upper Midwest are also struggling.

Even in places where the housing recovery has fully engaged, builders are having a hard time finding enough workers to cope with demand. The result has been foregone revenues, which may be delaying faster payments.

This has been the case especially in the Mountain West and, in particular, fast-growing states such as Utah and Colorado (see Chart 6). Strong job growth in a number of high-paying white-collar industries — such as professional, scientific, and technical services and tech-related fields — has drawn thousands of new residents to the region in recent years. In both states, the population has grown at almost twice the national rate throughout the recession and recovery, providing sufficient demand to mop up excess housing supply in the wake of the housing collapse.

All of Colorado’s metro housing markets are now undersupplied, and home values in Denver, Boulder and Fort Collins, Colo., have shattered records set before the Great Recession. Yet builders’ hands are tied until they can source enough qualified workers to ramp up homebuilding in these areas.

The case of the Mountain West is an exception, not the rule, and pockets of weakness are slowly becoming less widespread. Therefore, the housing recovery will continue to support small construction firms, and the recent drop in the number of accounts and balance volumes should prove temporary.

Growing concerns about agriculture

Credit conditions among small agricultural companies show a similar pattern to construction companies. The share of past-due balances declined 1 percentage point to 7.1 percent, a recovery low. However, the decline was driven by a smaller proportion of severely delinquent balances along with fewer trade accounts and a 0.5 percent decline

in total balances, again signaling lenders may be closing nonperforming accounts.

At least part of the problem is a decline in agriculture-related commodity prices, which caused a slide in farmers’ incomes in the Midwest in the second half of last year and into 2014. Corn prices began a steep decline in mid-2013, corresponding with a 30 percent reduction in the number of tradelines to farmers and a 36 percent drop in balances during that time.

The concern is that falling crop prices could spread to other parts of the Midwestern economy, where farming is a larger piece of the commercial pie. Farmland values soared to new heights as rising commodities prices drove speculation. Nowhere is this more evident than in Iowa, where the per-acre price of farmland was more than double the U.S. average in 2012.

The drop in corn prices raises the specter of a farmland value correction, and the downward trend in crop prices may not reverse itself right away. Not only will this hasten the slide in farm income, thereby slowing consumer spending, but it also could put a damper on capital expenditures for farm equipment and erode profits at manufacturers. The decline in crop prices should be watched closely, and if it does not abate, a backslide in small-business credit quality in the Midwest is a distinct possibility as consumers in the region face possible job losses and farmers spend what’s left of their income more frugally.


7

Looking ahead

Notwithstanding the industry-specific risks outlined above, the overall thrust of the small-business recovery remains positive. Steady revenue growth in most industries is an encouraging sign, especially for housing-related companies that were hit the hardest in the recession. Even though regional disparities will continue, the national trend in revenue growth will stick, which should induce stronger hiring in this sector.

Given the deep roots of housing in the economy, this pickup is key to the Moody’s Analytics forecast for accelerated growth through 2015, and recent revenue growth for small construction companies is a first indication that the forecast will play out to script.

A strengthening consumer recovery will reinforce the upswing in the small-business recovery. As a share of disposable personal income, household debt burdens are near record lows. Moreover, 2014 is on track to be the strongest year for job growth since 1999, and the composition of jobs being created has migrated toward

full-time positions in better-paying fields compared with earlier in the recovery.

Nascent signs of upward wage pressure are presenting themselves. The net share of small firms surveyed by the NFIB who plan on raising compensation over the next three to six months is at a recovery high. Historically, this metric has correlated well with future wage gains and would provide consumers with the most conspicuous missing piece to the recovery thus far: stronger earnings growth.

Data from the Bureau of Labor Statistics show inflation-adjusted average hourly earnings have been essentially flat since 2009. However, payroll data from ADP challenge this notion and indicate that businesses may have already begun doling out raises to workers. Either way, a lift in average earnings will fuel stronger consumer sentiment and spending over the next six months to a year, affording small companies the opportunity to continue getting ahead on debt payments.

The risk of a global slowdown has grown more prominent in recent weeks; a second-quarter contraction in German GDP sparked fears that a triple-dip

eurozone recession is imminent, and China’s economy grew 7.3 percent in the third quarter — not bad by global standards but still weak compared with previous performance.

Sanctions on Russia played at least a minor role in the German slowdown, but weak investment amid waning business confidence is still a major hurdle to a rebound in the eurozone. Another European recession would weigh on U.S. exports to the region, placing an additional burden on small companies, particularly in northeastern states. Similarly, a slowdown in China would cool shipments across the Pacific, which could ripple through to small companies on the West Coast.

However, economic fundamentals favor additional support from domestic demand in coming months, which should more than offset the effects of a temporary weakening in economies outside of the United States. All told, the Experian/Moody’s Analytics Small Business Credit Index should maintain its upward trend over the next couple of years as the U.S. recovery evolves into a full-fledged expansion.

Normalized,2004-2006=0

Chart 6: Builder Markets Tightest in the WestResidential construction employment-to-housing starts ratio, 6 month moving average

0.54 to 1.39

1.4 to 2.6

-1.64 to 0.53

U.S.=0.92

Sources: Census Bureau, BLS, Moody’s Analytics

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About the index

Experian joined forces with Moody’s Analytics, a leading independent provider of economic forecasting, to create a business index and detailed report that provides insight into the health of U.S. businesses. The Experian/Moody’s Analytics Small Business Credit Index is reported quarterly to show fluctuations in the market and discuss factors that are impacting the business economy.

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