Puerto Rico Small Business Sector Trends: Evidence from the 2018 New York Fed Survey

2017 was a challenging year for the Puerto Rico small business sector,¹ which represents 99.7% of all business establishments on the island.² Falling revenues and rising operating costs squeezed firm profits, and two major hurricanes adversely affected most of the sector and the island at large.

While a majority of hurricane-affected firms had some form of insurance, few were fully covered and few sought other types of financing to address hurricane-related losses. As a result, few firms fully covered their hurricane-related losses through insurance claims and financing applications. Most firms experienced a funding shortfall and demand for more financing continues into 2018 (see Puerto Rico Small Businesses and the 2017 Hurricanes).

There were positive notes, too. First, credit availability increased significantly in 2017. Even though demand for credit remained weak for the second year in a row, credit approvals for applicants increased significantly in 2017 relative to the previous year. If a firm applied for credit, it was more likely to have received funding, and often the full amount asked for in 2017.

An increased prevalence of debt aversion among firms may be contributing to the weak demand for credit. Also, the sector’s size composition shifted towards more micro-revenue firms with annual revenues of $50,000 or less. These firms may be driving the strong demand for small dollar loans, even as small as $10,000 or less. This size firm may also benefit from financial education and management services to help repair weak credit scores, fill gaps in credit histories, and learn how to collect and present appropriate documentation needed for successful credit applications.

Second, while Hurricanes Maria and Irma affected most of the sector, whether directly with storm damage or indirectly with hurricane-related losses in the aftermath, most respondents resumed operations even if they had closed temporarily. Only a few firms indicated they closed permanently, though these results are subject to survivor bias.³ Closures, whether temporary or permanent, were most often attributed to a lack of power, water, or transportation. However, structural damage to the business and lack of customers were also mentioned frequently and may have longer-term impacts on the sector. Waiting for funds from pending insurance claims and loan applications are challenges and sometimes even reasons for firm closures.

Lastly, there is optimism in the sector’s outlook toward the future. Firms are pursuing new opportunities and making entrepreneurial changes. A majority of firms plan to update their business by offering new or different goods or services in the coming year. Restructuring business processes and expanding the business outside Puerto Rico were also common strategies that businesses plan to pursue in 2018.

Takeaways include:

Sector Profile

• The share of micro-revenue firms in the sector increased in 2017.
  Micro-revenue firms comprise the majority of the sector. Most of these firms have annual revenues of $50,000 or less. The share of micro-revenue firms increased significantly in 2017 relative to 2016, possibly related to hurricane-related losses.
• Annual revenues decreased in 2017 for a majority of firms.
  54% of firms reported a decrease in annual revenues in 2017 relative to 2016. The distribution of revenue change magnitudes was similar to last year’s survey results. Also, on net, more firms reported decreases than increases or no change for the second year in a row.
• Operating expenses increased for a majority of firms in 2017.
  For the second year in a row, a majority of firms reported increased expenses.
• Profitability remained under pressure for firms in 2017.
  After having declined in 2016 relative to 2015, the share of profitable firms remained relatively stable in 2017. On net, more firms reported losses than profits in 2016 and 2017, as compared to the reverse in 2015.

Credit Demand

• Demand for credit remained low in 2017.
  Demand for credit declined in 2016, and remained low in 2017. In 2015, 55% of all firms applied for credit; in 2016 and 2017, this share was significantly lower at around 30% of all firms. The downward shift in credit demand is seen across the spectrum of firms.
  A contributor to weak credit demand in 2017 was an increase in the share of debt averse firms. While debt aversion has been the most frequently cited reason not to apply for credit over the last three years, it became significantly more important in 2017.
  Discouraged borrowers cite financial obstacles; opportunities persist for credit repair services for firms in 2017.
  Commercial banks continue to be the most frequently mentioned credit source. Government entities gained importance in 2017, most likely reflecting funding for hurricane recovery.
• Credit demand is primarily for small-dollar loans.
  81% of applicant firms applied for loans of $100,000 or less; 32% of applicants applied for loans of $10,001 to $25,000; and 23% of applicants asked for loans of $10,000 or less. Meeting operating expenses was the top-ranked reason to apply for credit in all three years of the survey.

Credit Availability

• Credit approvals increased significantly in 2017.
  While application rates were down in 2017, credit approvals increased. Increased availability was reflected in three ways: First, the share of firms that received funding, full or partial, was the highest in the past three years. Second, the share of applicants who received full funding reached a three-year high in 2017. Lastly, there was a decline in the share of those who were denied funding.
  Reasons for credit shortfalls and firm responses were little changed in 2017 from previous survey years. The most frequently cited financial barriers continue to be weak credit scores, weak credit histories, and/or a lack of necessary documentation. A notable change in 2017 was that more entrepreneurs downsized their business in the face of a funding shortfall than used personal funds or turned to alternative lenders than they might have done in the past.

Behind the Numbers: Differences Among Firms Within the Sector

Larger firms (by employment or annual revenues) and more financially successful firms (were profitable or broke even) are more active and successful in the credit markets. These firms apply for credit and receive full or partial funding more often than other small businesses. When these firms do not apply for credit, it is most often because they have sufficient funding.

In 2016, there was a significant decline in the demand for credit compared to the previous year, which was seen across the spectrum of firms in the sector; however, some types of firms exhibited larger declines than others. This decline in demand persisted into 2017, but was accompanied by sharply more credit availability for the larger and more profitable firms. As a consequence, differences emerged in funding success among firms, as noted previously.

Debt aversion is the top-ranked reason not to apply for credit. In 2017, it increased to 42% of non-applicant firms, which was higher than 38% and 36% for 2015 and 2016, respectively. While debt aversion rates were similar among firms in 2015 and 2016, the 2017 increase was concentrated among the smaller employment (10 employees or less) firms and more recently established (5 years or less) firms.

Firms with debt outstanding did not have lower approval rates than their peers. Having a bank in the mix of institutions applied to for credit was more often associated with an improvement in approval rates from 2016 to 2017.