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Small Business Underwriting: Same as It Ever Was

Adam Rust's picture

Posted October 10, 2012

Let's be honest: plenty of banks lack for any kind of imagination.

In most fields, the simplistic rote lessons taught in most schools are quickly replaced in the professional world by techniques that capitalize on experience and nuance. I went to journalism school back in the 90s. We were taught

to focus on the five W's and to write our leads the same way every time. A good lead was usually less than 14 words and it had no commas. Never mind that a lede from a Pulitzer Prize-winning New York Times lede can run on for a full paragraph (see Rick Bragg) - it was hard and fast formulas for students.

Later I went to business school. The content of the lessons differed, but the small business lending approach was still rote: DTI, DSR, LTV, current ratio, revenue growth, something about personnel, something about market share, and perhaps a few other well-worn ratios.

What do you find when you fast forward to practices in the real marketplace? It is like David Byrne used to say - "same as it ever was, same as it ever was." Even at a big bank, experienced small business loan officers are filling out boxes (or spreadsheet cells) with the information needed to calculate those same ratios.

Let's not forget, either, that sometimes imagination makes the difference between using capital and sitting on capital.

It is a difference that subsequently impacts scores of small businesses. In a down market, rote underwriting means a lot less lending. Last week's presidential election debate included several mentions of the virtue of small business, but even with that kind of political blessing its well-known that those firms are having a hard time getting loans - even small loans - for basic working capital. Loans guaranteed by the SBA are suddenly tightening up on underwriting standards to where the traditional method for qualifying for a loan - putting your home up as collateral - is increasingly difficult.

Lacking some broad imagination, businesses are saying that they want capital but banks are saying that they prefer not to lend. The Fed says that demand soared by 26 percent last year, but that lending remained about the same. Indeed, SBA lending declined by seven percent this year. Moreover, some SBA loans are not as generous as you might expect. Two of the top three SBA lenders in 2011 were credit card companies (Amex and Capital One).

The "new alternatives" increasingly seem to use high-speed data analytics to quicken the pace of lending. In general, I think this is a good thing. If something can be done faster and with the same level of intelligence, then there is no reason to stick to old ways. Empirically, this is more problematic. In the case of lending to individuals, no one out there is faster than the new guys in payday.

Speed takes money and money reflects priorities. Banks have pushed their investment in trading technology to the limits of the physical world, but they still take three months to calculate a debt-service ratio for a small business loan. My friends the currency traders tell me that their firms are running up against a problem with speed at their bank as well. Their firm has invested in platinum-tipped semiconductors and built data centers inside the NYSE, but they can only process orders as fast as the speed of light.