Latest Trends in Underwriting Small Business Loans

Are banks centralizing their operations to increase efficiency or are they keeping decisions local and close to customers? In the kickoff to RMA's 2017–18 Credit Risk Management Audio Conference Series, John O’Connor, Partner, Praxis Advisors LLC, discussed these questions facing small business lending leadership.

In the years leading up to 2007, small business lending saw growth of central lending groups with many focusing heavily on acquisition. In the downturn, banks with the highest portfolio deterioration lacked full credit-cycle management (weak PM and EWS), blamed largely on the poor copying of other banks' approaches.

As a result, process and policy became heavier, the use of scoring became limited or eliminated entirely, and lending centers were remapped to commercial and/or credit. The industry saw the rationalization of credit processes and policies with countering from compliance and regulatory as early as 2010. The market's response to banks’ retrenchment was the rise of fintech, which captured the attention of many banks. Fintech’s need for cheap deposits for a continual funding source presents an ongoing challenge.

There has also been a renewed focus on the centralization of functions and larger dollars. Many have false expectations on the value of centralization because there is an unrealistic belief that centralization alone brings efficiency. A full understanding of the importance of an end-to-end model design is needed.

O'Connor outlined several barriers to success—or opportunities to improve—for central lending centers:

  • Lack of fully integrated APS still drives heavy cost to centralized processes.
  • Multiple and manual input E2E should drive the use of fintech type solutions (customer portals, omnichannel, rationalization of input by role, embedded edit checks, or use of fintech for E2E for some segments).
  • Compliance routines rationalized and embedded versus band-aided in process.
  • Reduction of deals held for more information at each point of process.
  • Lack of field skills to target, interview, understand client needs, set client expectations, and provide a quality deal memo reduces centralization effectiveness from submission through closing.

As some have continued to define higher limits to centralize, banks have instituted credit officer support in select markets to better shape deals before being submitted.

Banks are beginning to use scoring and Score Plus at higher dollar levels in the decisioning process. Primary reliance is on traditional financial analysis. Many still do not have separate score cards for Score Plus versus score and have difficulty performing separate vintage analysis and validation.

Field overrides of all but the smallest decisions are still the norm. Credit and the business line believe this keeps decisions local with centralized efficiency. For many though, this is not true because of the field credit support system required to manage it.

For those banks that want local decisions, the process typically involves several layers of approval including:

  • Analysis and pre-decision, central or regional, then…
  • Post-approval functions (DD, DP, and funding) being performed by a variety of groups across geographic regions.

Join us for the next installment of the Credit Risk Management Audio Conference Series on October 10, State of Commercial Real Estate.

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