Risk-Off Keeps the Expansion Intact

March confirms the current “wait and see” mood

of private companies. On a macro level, private

companies are maintaining current production of their

goods and services in industries not directly exposed

to the ongoing commodity bust. Micro analysis shows

that most industry sectors are reducing investment in

production capacity as a sign of their bearish outlook

for the economy.

At the same time, the finances of private companies

remain strong but maybe too strong as loans past

due fell again in March. Construction remains the only

major sector driving this economy. Private companies

just don’t want to take on a lot of risk right now, and

that won’t drive GDP growth near-term.

Small Business Credit Outlook

2016 Q1

SB

LI O

rig

inat

ion

s In

dex

SBDI 91-180 Day Delinquency Index

PayNet Small Business Cycle

80

70

60

1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2%

90

100

110

120

130

140

1Q10

1Q11

1Q08

1Q05

1Q071Q06 1Q15

1Q16

1Q14

1Q13

1Q12

RECES

SIO

N EXPANSION

CONTRACTION

RECOVERY1Q09

0%

Business CycleThe reward part of the risk/reward

equation took a hard turn south

in the 4th quarter of 2015 which

thankfully abated in the 1st quarter

of 2016. In another encouraging sign,

the investment plunge has not been

coupled with deteriorating financial

health.

As a result, we can say that the

business cycle has averted an

inflection, but the odds of a cycle

change have certainly increased.

Small businesses sharply curtailed

investments to build more, invent

new products, or to make their plants

or operations more efficient. As can

be seen in Figure 1, investment and

credit risk found a bottom in the 1st

quarter. While the plunge in Q4 was

unwelcome, at least we can say that it

is not continuing.

A cautious reaction would be to

stop lending to borrowers, to limit

concentrations to segments that are

exposed to US consumers, and to

start pulling in lines of credit. While

caution can be a sound strategy, it can

also be costly through missed growth

opportunities. Lower investments with

steadily low loan delinquencies means

that the business cycle phase remains

in moderate expansion at low risk.

-20%

-15%

-30%

-35%

-40%

-25%

-10%

-5%

0%

5%

10%

15%

20%

25%

35%

40%

30%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

80

70

60

90

100

110

120

140

150

130

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20162005

Inde

x Va

lue

Thomson Reuters/PayNet SBLI Year-Over-Year Change(January 2006 - March 2016)

Thomson Reuters/PayNet Small Business Lending Index (SBLI)(January 2005 - March 2016)

Recent Investment ActivityThe Thomson Reuters/PayNet Small Business Lending

Index (SBLI) seasonally adjusted originations decreased

3% from 138.9 in February 2016 to 135.3 in March 2016.

The small decrease in the Index comes one month after

the largest monthly increase in the Index’s history in

February.

Compared to the same month one year ago, the Index

is up 4%, however, the rolling three-month Index is

essentially flat from February 2016 and is up 3% as

compared to the same period one year ago. The rolling

three-month Index held steady after five consecutive

months of decreases from September 2015 to January

2016.

Consumer staples sectors show

the most expansion by industry

segment. Construction (+9.2%),

Retail Trade (+6.6%), and Real

Estate Services (+5.5%) show the

largest year-over-year increase in

investment. The lagging sectors

continue to be commodity based

with Agriculture (-19.0%), Mining &

Quarrying (-16.4%), and Wholesale

Trade (-3.5%).

The striking point is that most

industry sectors show investment

at a 1 – 4% range which means that

they are in a maintenance mode of

replacing worn-out assets rather

than undertaking organic expansion.

One Year Change in New Originations

NAICS Industry Segments March 2016 YoY Change

Construction 9.2%Administrative and Support Services 8.4%Retail Trade 6.6%Real Estate and Rental and Leasing 5.4%Finance and Insurance 4.0%Transportation and Warehousing 3.8%Other Services (except Public Administration) 3.7%Manufacturing 3.3%Health Care and Social Assistance 3.2%Arts, Entertainment, and Recreation 2.4%Public Administration 1.7%Professional, Scientific, and Technical Services 1.3%All Industries 1.0%Educational Services 0.7%Accommodation and Food Services -0.3%Information -2.3%Wholesale Trade -3.5%Mining, Quarrying, and Oil & Gas Extraction -16.4%Agriculture, Forestry, Fishing and Hunting -19.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20162005

1%

0.5%

0%

1.5%

2%

2.5%

3%

3.5%

4%

Inde

x Va

lue

-20%

-15%

-30%

-35%

-40%

-25%

-10%

-5%

0%

5%

10%

15%

20%

25%

35%

40%

30%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Thomson Reuters/PayNet Small Business Delinquency Index (SBDI)(31 - 90 Days Past Due)

(January 2005 - March 2016)

Thomson Reuters/PayNet SBDI Change vs. Year Prior (31 - 90 Days Past Due)

(January 2006 - March 2016)

Credit RiskWhat is particularly concerning is

that risk taking is not accelerating.

The Thomson Reuters/PayNet Small

Business Delinquency Index (SBDI)

31-90 days past-due held steady at

1.21% from February 2016 to March

2016. As compared to one year ago,

delinquency decreased 3 bps; this is

the 10th consecutive month of year-

over-year decreases after 12 straight

months of increases.

Transportation delinquency is up 5 bps

to 1.28% - its 13th consecutive month

of increase and its highest level since

April 2013. Agriculture delinquency

is up 3 bps to 0.63% - its sixth

consecutive month of increase and its

highest level since August 2011. Health

Care and General delinquencies each

decreased 1 basis point.

Loans severely past due increased

slightly signaling continued benign

credit risk.The Thomson Reuters/

PayNet Small Business Delinquency

Index (SBDI) 91-180 days past-due

increased 1 bp from 0.26% in February

2016 to 0.27% in March 2016. The

Index is up for just the second time in

the past 19 months. As compared to

one year ago, delinquency is down 8%

(2 bps) - the 11th consecutive month

of year-over-year declines after 12

months without

a decrease.

Transportation delinquency increased

1 bp to 0.35% - its seventh consecutive

month of increase and highest

level since April 2012. Agriculture

delinquency increased 1 bp to 0.19%-

its fourth consecutive month of

increase and highest level since April

2011. Health Care delinquency fell 1 bp

and was the only segment to see a

decrease.

Regional PerspectiveThe Southeast and Northeast are currently driving U.S.

economic growth. Investment by small business, which

is measured by lending activity, has risen the most in

Florida (+10.3%), North Carolina (+6.2%), and Georgia

(5.3%).

Lagging states reflect the systemic problems in the

energy and agriculture sectors. Illinois lags the most

at -5.2% and Texas follows at -2.6%. Michigan (+4.2%),

California (+3.7%), New York (+3.2%), Ohio (+3.1%),

and Pennsylvania (+2.4%) show small businesses

operating at maintenance levels as opposed to organic

expansion. The trend line for the 10 largest states

shows 5 increasing and 5 decreasing.

1.50%1.00-1.50%0.50-0.99%< 0.50% >

PayNet Small Business Delinquency Index by State (31-90 Day)

HI

WA

OR

CA

NV

ID

MT

WY

UT

AZ NM

CO

ND

SD

NE

KS

OK

TX

MN

IA

MO

AR

LA

WI

IL

KY

IN

MI

TN

MS AL

OH

PA

WVVA

NC

SC

GA

FL

ME

NY

VTNH MA

RICTNJDE

MDDC

AK

Delinquency of 10 Largest States(31-180 Days Past Due)

State SBDI

March 2016YoY Change

New York 1.49% -0.49%Illinois 1.41% -0.26%California 1.29% -0.25%Florida 2.04% -0.08%Georgia 2.02% -0.07%United States 1.47% -0.06%North Carolina 1.55% -0.04%Pennsylvania 1.68% -0.02%Ohio 1.14% 0.02%Michigan 1.39% 0.19%Texas 2.19% 0.42%

Credit risk improved in most of the

10 largest states reflecting restrained

investment and a return to lower credit

risk. Year-over-year loans 31-180 days

past due stand lower in 7 of the 10

largest states. New York (-0.49%),

California (-0.25%), and Illinois (-0.26%)

display the largest decreases in loans

past due.

Credit risk has risen the most in Texas

(+0.42%) and Michigan (+0.19%), but

Texas reflects a batten-down-the-hatches

setting while Michigan is one of the few

states presently in a risk-on mode. The

following table shows 31-180 days past

due for the 10 largest states.

Credit Risk ForecastOf note is that risk in the economy

remains low reflecting the prevalence of

economic restraint.

The data show that business defaults

are forecasted to reach 2.0% for all

of 2016, versus our prediction of 1.9%

at the start of the year. Industries

that are driving the increase include

Transportation +0.9%, Mining +0.7%,

Construction +0.6%, and Agriculture

+0.8%.

Historical And AbsolutePD® Forecast Default Rates

IndustrySegment

Actual Historical Default Rates (1) Forecast Default Rates (2)

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016* 2017

Transportation 4.3% 6.4% 10.1% 12.4% 7.8% 4.2% 2.8% 2.7% 2.5% 2.7% 3.8% 3.0%Information 3.5% 4.4% 4.9% 6.7% 3.6% 3.5% 2.9% 2.4% 2.2% 2.3% 2.3% 2.1%Mining 1.0% 2.6% 3.5% 6.8% 4.8% 2.1% 1.8% 1.2% 1.3% 2.3% 3.0% 2.3%Retail 2.5% 3.2% 4.4% 6.3% 4.3% 2.5% 1.9% 1.7% 2.1% 1.9% 2.0% 2.1%Construction 2.7% 4.3% 6.7% 10.5% 7.5% 3.7% 2.2% 1.7% 1.6% 1.9% 2.5% 2.4%Accommodation and Food 4.0% 5.1% 6.8% 7.7% 6.0% 3.2% 1.7% 2.0% 1.6% 1.8% 2.1% 2.6%Health Care 2.5% 3.0% 3.7% 4.2% 3.5% 2.1% 2.0% 1.9% 1.8% 1.8% 1.9% 2.0%Professional Services 2.7% 3.5% 4.3% 5.3% 3.5% 2.4% 1.9% 1.7% 1.6% 1.7% 2.0% 1.8%Administrative Services 2.4% 3.1% 4.3% 6.1% 4.5% 2.7% 2.1% 1.9% 1.8% 1.6% 2.1% 1.9%Manufacturing 2.1% 2.4% 3.3% 5.8% 4.1% 2.3% 1.6% 1.3% 1.5% 1.6% 1.8% 1.7%Agriculture 2.0% 1.8% 1.8% 2.7% 2.3% 1.5% 0.9% 0.8% 0.9% 1.4% 2.2% 1.8%Wholesale 1.9% 2.1% 3.0% 4.2% 3.2% 1.9% 1.2% 1.1% 1.2% 1.3% 1.6% 1.8%Other Services 2.4% 2.7% 3.9% 4.8% 3.1% 2.1% 1.6% 1.3% 1.2% 1.3% 1.8% 1.8%Finance 3.5% 7.5% 7.1% 5.8% 3.5% 2.0% 2.0% 1.4% 1.1% 1.3% 1.7% 1.6%Entertainment 3.3% 3.7% 4.2% 4.2% 2.7% 2.3% 1.7% 1.3% 1.1% 1.0% 1.8% 2.1%Education 2.4% 2.5% 2.8% 2.9% 2.0% 1.4% 1.4% 0.9% 1.1% 1.0% 1.6% 1.9%Real Estate 2.1% 3.2% 5.0% 6.6% 4.1% 2.5% 1.4% 1.3% 1.2% 1.0% 1.8% 1.8%Public Administration 2.5% 2.8% 1.9% 2.4% 1.6% 1.5% 2.0% 1.2% 0.9% 0.6% 1.6% 1.9%ALL INDUSTRIES 2.6% 3.6% 4.8% 6.2% 4.2% 2.5% 1.8% 1.6% 1.5% 1.6% 2.0% 1.9%

$1.0mm or Less in Total Lease/Loan Exposure *2016 Forecasts Include 1 Quarter of Actual Defaults

Source: (1) PayNet Small Business Default Index (2) PayNet AbsolutePD®

SummaryA risk-off scenario isn’t good for

investment and will likely restrain GDP

growth this quarter. However, risk-off

reduces chances of imbalances and

over-investment and creates favorable

conditions for future growth. Improved

credit risk positions businesses to

accelerate their investments beyond

the 3% rate that we see now.

Once political, economic, and

geopolitical uncertainties become

clearer, small businesses are poised

to once again become a driver of

GDP growth given the favorable

financial picture and outlook for the

US consumer. In a risk-off climate, GDP

will remain moderate and below its

long-term potential.

Credit quality, measured in terms of

default rates, is forecast to register

2.0%. This is still well below pre-

recession default rates rendering a

good sign for lenders.

About PayNet, Inc.PayNet is the leading provider of credit ratings on small businesses enabling lenders to achieve optimal risk management,

growth, and operational efficiencies. PayNet maintains the largest proprietary database of small business loans, leases, and

lines of credit encompassing over 23 Million contracts worth more than $1.3 Trillion.

Using state-of-the-art analytics, PayNet converts raw data into real-time marketing intelligence and predictive information that

subscribing lenders use to make informed small business financial decisions and improve their business strategy.

PayNet’s small business capabilities range from historic credit-reporting and automated credit-scoring to detailed strategic

business reviews that include portfolio risk measurement, default forecasting, peer benchmarking, and critical industry trend

analysis.

PayNet Contact InformationPayNet, Inc.

5750 Old Orchard Rd., Suite 300

Skokie, IL 60077

866-825-3400

www.paynetonline.com

William Phelan

President

866-825-3400

bphelan@paynetonline.com

Taking the Risk Out of Small Business Lending

For more information please call (866) 825-3400

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