Back to the Basics

At the end of each year, I think about lessons learned. The windup of 2018 is no different. What did we see financial institutions doing well? What are the areas needing improvement?   

As we move into 2019, I think we need to look at the basics. Is your financial institution following processes that work or processes that have always been a certain way? Is there a better way to lend and manage your portfolio?

One area that continues to be an issue for many financial institutions is segmentation of the commercial portfolio. This manifests in two ways:

  • The financial institution has never segmented its commercial portfolio and treats all loans, large and small, the same.
  • The bank “claims” to have segmented its commercial portfolio and defined small business. However, the underwriting and analysis is the same as commercial. Nothing is streamlined.

In the scenarios above, the issue is the same. The financial institution has not changed its process to create efficiency in small business lending. Instead, it is relying on traditional commercial underwriting and losing the benefits of segmenting the portfolio.

Many financial institutions, particularly those under $1B in assets, question the need to segment their portfolio. At any asset size, there are tremendous efficiencies to be gained by segmenting the commercial portfolio:

  1. It allows the commercial loan origination team to focus on the higher dollar/more complex relationships and provide a better client experience.
  2. Resources that understand the risk of larger, more complex credits can focus on those instead of trying to cover all dollar sizes and complexities.
  3. Smaller dollar transactions are not overlooked, since they become of the priority of the small business origination team.
  4. The branches or Small Business Officers, rather than Commercial Lenders, can manage small dollar transactions.
  5. With a targeted origination and underwriting team, the small business customer experience is enhanced.
  6. Scoring can assist to streamline the approval process for small business, which shortens decision time. Even without auto decisioning, a blended business score can guide underwriting and focus analysis to needed transactions.
  7. Small business requests can be priced appropriately using risk based pricing. This will allow a more consistent spread (based on risk) to be applied to the smaller dollar transactions. Without portfolio segmentation, small business loans tend to be priced as if they are large commercial.
  8. Loan package requirements can be tailored. Large, complex relationships require multiple year financial statements, interims, projections, etc. Small dollar transactions can focus on tax returns or no financial information, as appropriate.

This list of benefits is just a beginning. Segmenting the portfolio allows everyone to focus time and resources where needed. It enhances the customer experience for commercial and small business. In a competitive market where turnaround time is crucial (some online funding sources can decision a request in under 3 hours), small business loan decisions need to be fast and not overly complex.

Collecting multiple years of financial information for a small business loan does not lower risk. Especially since the financial statements will most likely not be reviewed. Understand your true risk, segment the portfolio, and gain the benefits of efficiency for small dollar transactions. Leverage scoring and proactive portfolio management to balance the risk of obtaining less information. Let the commercial team focus on the more complex relationships.

This post is part of The Ultimate Guide to Selecting the Right Loan Origination System.