Business Default Index Shows Business Credit Quality Strongest in Four Years

from WAIN Street

The WAIN Street Business Default Index posted a 0.19% improvement in December – its third consecutive monthly improvement – to close the year at 6.25% – its best reading in four years. The index is quoted as a seasonally adjusted, annualized default rate. An increase in the index corresponds to deterioration in business credit quality. In December, nearly 5% more businesses improved in credit quality than deteriorated.

Businesses of all sizes across industries and geographies improved during 2013. Said Vidur Dhanda, Publisher, WAIN Street:

2013 ended on a high note with most economic indicators painting a picture of better days ahead. Businesses fared better and that was reflected in their credit performance during the year. A frequent question in 2013 was ‘Are we there yet?’ and the year ended with another question: Will the job market play spoiler?

Highlights from the Q4 2013 report:
— LA, SD, AK, and VA businesses lead the nation in credit quality
— NV, AZ, and IL businesses have the worst credit quality
— Manufacturing sector businesses have highest default rate
— “Leisure & hospitality” and “Other services” sector businesses have the highest credit quality
— Mining sector businesses posted biggest improvement in credit quality

The WAIN Street Business Default Index is computed monthly based on the credit performance of nearly 18 million US businesses that have been tracked by WAIN Street for over 12 months.

[click on image below to read the full report]

Caveats, Notes and Observations on this report:

[Editor’s Note: This data set has a short history so interpretation is difficult. Based on the mid-2000s the default trend might be a lagging indicator for the business cycle.]

WAIN Street mined what is arguably the most comprehensive database of firm-level defaults – the database underlying WAIN Street’s Business Default Index – to get a better sense of business credit quality trends from before the start of the Great Recession.

Legend for above graph:

Aggregate	All businesses
Solos	Businesses without paid employees
E20	Businesses with 10 to 19 employees
E100	Businesses with 20 to 99 employees
E100+	Businesses with 100 or more employees

Key Takeaways

• From their lows of 2006, business defaults peaked in 2008 followed by a three-year period of considerable improvement. They have continued to improve since then and are now at their lowest levels in ten years broadly mirroring Federal Reserve statistics on commercial lending.
• The drop in default rates is most likely the result of a combination of factors.
  • Lenders have cleaned up their books so there are fewer defaults from “previous” exposures.
  • Lenders have tightened standards so new exposures are to stronger businesses that default at a lower rate.
  • General business conditions have improved and businesses are better positioned to meet their financial obligations.
  • Borrowers have dropped out of the “traditional” credit markets discouraged that the cumbersome application process would most likely result in a rejection.

• There are surprising differences in credit quality between businesses of different size.
  • Solos—sole proprietorships, self-employed and other businesses without employees have the lowest default rate. Ignored from most statistics because of their less than four percent share of total business receipts, they directly impact the lives of over 20 million people and generate nearly a trillion dollars in receipts.
  • E100—businesses employing fewer than 100 and more than 20 have the highest default rate. They are a diverse group, squeezed in the middle, financially independent of the owner/operator, informationally opaque, and too small for special attention by the financial markets.
  • E20’s are the credit quality gems. Employing fewer than 20, they are the true small businesses and largely underserved by the credit markets.
  • E100+ businesses account for the bulk of business employment and receipts and garner the most attention. As a group, their default rate is similar to that of their smaller counterparts—E20’s.

• There are opportunities for better serving the credit needs of businesses.
  • E20 businesses represent an attractive segment for alternative lenders.
  • Solos deserve another look. Lenders’ traditional approaches might be shutting out a potentially vibrant, growing and profitable segment of borrowers.