Small business lending is poised for an interesting year in 2017. Small business confidence scores are riding on a 10-year high. Alternative lenders, including online, marketplace, and peer-to-peer, are becoming more active. Regulators are determining how the new “special purpose” charters will be structured. Now is the time for your institution to determine a strategy for living in a market that will likely see many more commercial credit applications. While this plan includes the loans you approve, it must also address how you will handle loan declines.
Statistically speaking, small banks approve around 50% of the commercial loan requests that enter their office (Source Biz2Credit, graph above). To maximize your business opportunity you should be asking about the other 50%. Is there an opportunity for future business from that pool of applicants? Can your institution still have a banking relationship with that business even if they do not currently meet your credit standards? Could you maintain deposit accounts for that applicant while helping them obtain financing at another source? Could that loan be incubated for your review at a later date?
The majority of small business loan declinations are due to time in business, poor personal credit score of the owner, lack of collateral, and weak financial metrics (such as high leverage or poor cash flow). All of these measures change over time, and conditions can either improve or decline after you render your credit decision. In most cases, once you decline a loan, the business owner will seek financing at another source. This could be an alternative lender, a family member or an outside investor.
As an advocate for small businesses, your next question should be, “How can I help that business with its journey?” It is one thing to just say, “No.” It is quite another to fully explain why your organization cannot provide the financing and then to offer potential solutions through other sources.
In recent years, some large banks have partnered with alternative lenders to place many of these declined businesses. But that option is limited since the bank is only offering one financing entity. A better option would be to allow the business to see multiple financing offers from vetted alternative lenders.
Here is a four-step method for nurturing your loan declines.
- When declining the loan, take the time to explain why your institution cannot provide funding, and under what circumstances it might be able to do so in the future. Make sure to be specific regarding your approval standards.
- Help educate the small business owner regarding other financing options in the marketplace. If owner experience is an issue, point them to resources such as SCORE or a small business development center.
- Partner with alternative lending resources that can fund some of your declines. Make sure these resources offer the opportunity for you to review the credit in the future as conditions improve. In effect, this allows you to incubate the credit with an alternative lender.
- Work to maintain the non-credit portion of the banking relationship with the applicant. This allows your staff to nurture the client with depository services, hopefully gaining new business credit in the future.
This process helps you maintain goodwill in your community while building a pipeline for future small business relationships. It is also good for business since many of these alternative financing options will structure referral fee arrangements with you. Most importantly, it sends a message to the small business community that you care enough to spend the extra time helping them get the funds they need to prosper. It’s precisely the sort of thing they will notice and remember.