While speaking with friend and 30-year small-business banking veteran Charles Green (a contributor to the industry newsletter, Coleman Report) about his upcoming book, it became very obvious that bankers and borrowers are in the same boat — the times, they are a change’n, and neither group knows what they don’t know.
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What are the bankers missing?
Since 2008, the small-business bankers who survived the meltdown have been faced with increased regulation and an increasing inability to help the small businesses within their communities. Following the financial crisis, access to capital for Main Street basically disappeared. If that capital were water coming out of a tap, the situation didn’t slow the flow to a trickle — it basically got shut off completely.
Things are improving for small-business owners, but many of the banking relationships Main Street relied on for capital have moved upstream to bigger and potentially more profitable fish. A well-established company with five to 10 years of track record and real estate or equipment for collateral is simply considered a better credit risk.
The vacuum in the market created by the large-scale exit of traditional small-business lenders like banks and credit unions created an opportunity for non-bank specialty lenders to gain a foothold and even push bankers aside in favor of the more streamlined loan application process and quicker access to cash offered by these non-bank lenders — even when their offerings are more expensive than a traditional loan.
It’s true that many of the borrowers who find capital with these non-traditional lenders are business owners most banks might not finance anyway. They are either start-ups, have less-than-perfect-credit, or otherwise don’t fit within the risk profile a traditional banker is looking for. Nevertheless, those aren’t the only small-business owners taking advantage of the offers made by these alternatives to the bank. Many of the best, most qualified borrowers are also embracing the quick access to capital offered by these lenders, allowing them to take advantage of market opportunities with access to short-term financing.
Unfortunately, many bankers are unaware this is even happening.
“Outside banking, many companies have reformed their credit criteria and changed their outlook on risk, based on the nature of their lending or theories on funding risks,” said Green. “For example, non-bank working capital lenders long ago stopped obsessing over credit reports and other information for a simple reason — their lending relationships gave them control of borrower cash accounts. Late car payments and medical bills of the business owner were inconsequential as to whether they would be repaid.”
Neither Green nor I suggest a willy-nilly approach to how small-business borrowers go through the application process, but non-bank lenders are looking at what Green calls “seemingly unthinkable borrower attributes and a range of other metrics (or semi-metrics) to define borrower risks, measure repayment capacity, and price funding.”
In other words, those Green describes as “computer geeks” have figured out, in just a few years, how to match the loan performance of more than 100 years of banking experience — and in many cases beat it. In fact, these non-bank lenders Green refers to as “innovative lenders” rather than alternative lenders are looking at small-business owners from a different paradigm. They’re finding many of the borrowers a bank might shy away from are really good borrowers. Looking beyond a credit score, they’ve found dozens of other metrics that are better at predicting whether or not a potential borrower will make regular and timely payments.
This creates a potential crisis for small-business borrowers who would prefer to borrow from a bank they know, the bank where they have deposits. It’s problematic for the bank or banker who continues to lose market share to non-bank lenders (which they might not even recognize) — market share they really can’t afford to lose. What’s more, it’s not like community banks haven’t been dropping like flies all across the country over the last 10-15 years as they get consumed by their bigger brethren, or simply disappear.