Putting Defaults In Place

As we reported for Q4 2013, US businesses closed 2013 with the lowest default rate in four years.  We 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.

bdx.annual.emp

Legend

Aggregate All businesses
Solos Businesses without paid employees
E20 Businesses with 1 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.