Amid market volatility and inflation, many economists believe we’re poised for an economic downturn or a recession. For small- to medium-sized businesses (SMBs) and those who lend to them, priorities are shifting.
Enigma partnered with Fintech Nexus to host a virtual panel discussion about how to navigate SMB lending in a down market and why data will help us weather the impending storm. Here, we break down the top takeaways from the discussion and actionable insights for lenders.
Who are U.S. small businesses and what are their capital needs?
First, let’s clarify who we mean by small and medium businesses.
Many of today’s small businesses are very small: roughly 85–90% of small businesses in North America employ fewer than 20 people, says Chris Scislowicz, Managing Director and Head of Lending at Accenture, and of those, 50–55% are sole proprietors. The average revenue for a small business is $60,000.
Small business owners tend to need access to short-term capital like credit cards, lines of credit, and term loans. They’re spending their time focused on running their businesses, so it’s important that we meet them where they are and offer lending options that are fast and convenient, Chris says.
The pandemic accelerated the digitization of small and medium businesses, which could prove to be a silver lining if we’re heading into a downturn that requires more agility and flexibility.
Onto the question of a downturn.
Economic outlook: is a recession looming?
While none of the panelists profess to predict the future, they’re monitoring economic indicators closely and drawing upon past experience with the 2008 financial crisis.
Classic signs of a downturn include a drop in payment rates and uptick in delinquencies. But before these manifest, the first indicators are changes with spending patterns and levels – especially discretionary spending – among small business owners and consumers, according to Lakshmi Narain, Managing Vice President of Apollo, a subsidiary of Capital One.
A few of the panelists’ observations so far:
Consumers keep spending
Despite market turbulence and uncertainty ahead, Mastercard data shows consumers are continuing to spend—but the mix is changing, says Jane Prokop, Mastercard EVP of Small and Medium Enterprises.
Retail sales (excluding automotive) were up in August, about 12% year-on-year and up about 20% compared to August 2019
Online sales grew about 10% compared to 2021
The mix across sectors is dynamic. Sectors that focus on consumer experiences, like restaurants, airlines and lodgings, saw strong double-digit growth last year
Mastercard expects retail sales for the 2022 holiday season to increase about 7% from last year, with a small bias toward in-store sales (8%, versus a projected increase of 4% in ecommerce)
SMB owners continue to spend
Spending by SMB owners seems to be resilient globally, with double-digit year-on-year growth that has been accelerating since August 2022.
Certain categories, like food, warehousing, professional services, and travel and entertainment, have experienced the most significant growth, according to Mastercard data.
Credit risk is normalizing
Lakshmi says he’s seeing credit risk continuing to normalize, although it’s still below pre-pandemic levels. SMBs are still spending but they’re showing caution given inflation, increasingly price-sensitive customers, and a wariness to pass on increased cost of goods to customers.
Lakshmi sums up lending conditions with this driving analogy: “If you’re a typical lender, you still have one foot on the accelerator and the other foot on the brake, holding your steering wheel tight and watching who you’re giving a ride to. And if you’re a typical borrower, you’re asking yourself, ‘Can I afford that ride, given it’s starting to get expensive and starting to get a bit bumpy along the way?’ But overall, conditions still look good.”
Individual small business performance has declined in 2022
Enigma is also seeing spending increase at the macro level. But when it comes to individual SMB performance, Enigma Chief Product Officer Scott Steinberg says the percentage of small businesses with revenue growth dropped by ten percentage points from the beginning of 2022 to the end of the third quarter, according to a sample of Enigma data on small business monthly card revenue.
At the beginning of 2022, the percentage of small businesses that were growing (adjusted for inflation) was about 60%. By the end of Q3, that number had dipped to below 50%.
And yet: SMB owners are a resilient, opportunistic group
Small business owners continue to show themselves as a resilient and opportunistic group, Lakshmi says. New business launches are still on the rise since the pandemic catalyst, when we saw a 23% increase in startups year-on-year. New businesses emerging today are tapping into opportunities of the rising cost environment and disruption in the market.
What’s different about this downturn?
Today’s leaders draw upon lessons from not only the financial crisis of 2008 but a lingering global pandemic.
Fortunately for lenders and small businesses, if we’re staring down another economic slump, we’re bolstered by technology tools that can enable more informed, fair and thoughtful decisions than ever before.
And there’s still work to do. Panelists reflected on a few opportunities and trends in particular.
Historical models for analyzing borrowers are out of date, says Chris. Micro-segmentation is a trend we've seen emerge during the pandemic and will be especially relevant as we head towards a potential recession.
Before the pandemic, if a bank was considering lending to a restaurant in a particular geography, it would look at the economics of that area. When COVID hit, lenders needed to know whether a restaurant offered takeout and delivery services. Lenders also needed to know whether businesses were considered an essential service.
The way businesses are evaluated will continue to evolve as data plays a bigger role in underwriting decisions, Chris says.
Greater focus on portfolio monitoring
In the last six months, Scott and the team at Enigma have observed a “sea change shift,” especially among fintech partners, in investments to “beef up” their portfolio monitoring capabilities. They want to ensure those capabilities are where they need to be “if the economy is heading the way we expect it to go,” he explains.
Use all the data
Jane says it’s important for lenders to use all the data they have at their disposal, and that it’s critical to consider things like the relative diversity of an SMB’s customer base.
“They could have terrific revenue from two customers and then that revenue can disappear practically overnight if they lose one of those customers," Jane says. "Understanding the details behind the cash flow is really important, particularly as you go into these kinds of periods when there could be severe disruptions in business.”
Data and decisions with intention
Chris cautions lenders to remember that the availability of data needs to go hand in hand with “procedural and process maturity” and that it’s critical to consider how to leverage that data appropriately. We should be asking, “What's important to make a decision? What are we allowed to use to make a decision? What's morally or ethically appropriate to make a decision based on?”
2023 and beyond: The need for speed (and agility)
Lakshmi notes that the SMB lending industry is better equipped than it was in the “Great Recession” of 2008-2009. He thinks thriving through a recession comes down to two things: how fast you can detect change or insight, and how fast you can act on what you detect.
“Technology has come a long way, both in providing the ability to access real-time data and in the applied science behind detecting patterns, trends and anomalies from using that data,” Lakshmi says.
Generalized credit scores are an incomplete picture of a business’ overall “wellness.” Platforms that incorporate alternative data sources, like Enigma, can increase approval rates dramatically.
As we look to the future, clear visibility into card revenues, revenue growth, transaction volumes and other metrics of financial performance can help lenders help more small businesses grow and thrive.
This article is based on a panel discussion presented by Fintech Nexus and Enigma. Watch the replay.