Increasing small-dollar SBA loans could have incredible impact on the small business community.
Lendio
Having an idea is easy; executing the vision is the hard part, according to Guy Kawasaki. As one of the original employees responsible for marketing Apple’s first Macintosh computer in the 1980s, he should know.
However, executing a vision requires access to capital, and America’s small businesses, particularly those qualified under the SBA, are facing a significant shortage of funds.
Earlier this summer, I had the opportunity, alongside other lenders, to meet with senior executives at the Small Business Administration in Washington. Together, we presented a three-pronged strategy aimed at increasing small-dollar SBA loans of $150,000 or less. Our goal is to make them more affordable for lenders, more attractive for SMBs, and more profitable for the SBA. Here’s what we shared with them.
SBA-Qualified Borrowers are Essential for the Health of the Lending Community
Running a business that is designed for long-term success and capable of pursuing its vision requires timely access to the right capital. Financial institutions play a crucial role in the success of SMBs. Among lenders, the most respected SMBs are those that qualify for SBA loans due to their creditworthiness and strategic use of capital.
Maintaining a strong relationship between SBA-qualified borrowers, loyal and creditworthy consumers, and lenders is vital. According to data from Lendio’s latest whitepaper, “Modernizing the Lending Experience for SBA-qualified Borrowers”, SBA-qualified borrowers are more loyal to their banks or credit unions than the general population of borrowers. However, they’re open to seek alternative lenders if they feel their needs are not adequately met, customer service is lacking, and they can find a better digital banking experience elsewhere.
Making Smaller Loans Profitable Means Using the Right Data
Approximately ten years ago, the SBA introduced the SBSS (Small Business Scoring Service) to assign a numerical scoring value to individual borrowers based on their creditworthiness and perceived ability to repay a loan in full. While helpful in theory, lenders often become complacent with a metric that has proven inaccurate over time, leading to loans that underperform and have severe repercussions for both lenders and borrowers.
Analyzing cash flow data effectively addresses this issue. This information is vital because it is unalterable, allowing lenders to accurately evaluate an SMB’s cash flow and overall financial health. Platforms like Lendio’s Intelligent Lending offer banks and financial institutions access to this valuable data, providing deeper insights and resulting in a 45% reduction in manual underwriting costs for lenders who utilize cash flow analysis. In addition to making these loans more profitable, it is also essential to minimize the human resources required for the underwriting process, so that a greater number of smaller-dollar loans can reach borrowers.
Risk-Adjusted Pricing Can Make Smaller Loans More Efficient
Our data indicate that approximately 85% of small businesses in America are seeking a loan of less than $150,000; however, underwriting such small-dollar loans is not beneficial for lenders.
When they do, they often apply the same underwriting standards to a million-dollar loan as they would to a $100,000 loan, resulting in a prime interest rate of 4-6% over a ten-year term or 20-24% at a five-year term. The process is too time-intensive and costly, with not enough ROI for lenders to continue pursuing and untenable lending terms for SMBs to accept.
Risk-adjusted pricing, where the terms are dependent on the borrower’s risk profile, could make these loans easier to underwrite, more profitable, and better performing for lenders, thereby addressing this issue.
Helping a New Administration Succeed
The new Small Business Administration, just six months into its term, faces a challenging task: addressing what it believes is a failing portfolio. Given the data available, it’s not surprising that they are convinced that larger dollar loans are the key solution.
They have also begun implementing significant policy changes, including stricter ownership requirements, staff reductions, and office restructuring.
Like many new administrations, they are eager to demonstrate their value to Americans and correct the perceived mistakes of their predecessors. However, they should avoid drastic measures that could undermine existing systems. Our goal of supporting SMBs and lenders must also include ensuring the SBA’s success. The SBA is a vital partner in the quest for access to capital, and building strong working relationships is essential. So, what does this mean for the future of lending?
SBA-qualified borrowers are at the forefront of SMB lending, and any shifts in their expectations will significantly impact the market. Both lenders and the SBA should pay attention to these trends to maintain this crucial relationship and make improvements to small-dollar loans a top priority.
The lending community believes change is possible. Our next steps will involve surveying lenders who currently provide small-dollar loans and hosting a summit to discuss best practices and offer recommendations to the SBA.
To increase small-dollar loans to SMBs, strong partnerships, open lines of communication, and a greater reliance on effective analytics will be critical.
