Small business owners are the backbone of the economy. They create jobs, spur innovation, and help drive economic growth. However, they often face significant challenges in accessing the capital they need to start or grow their businesses. In this episode, David Smith, a Senior Originations Consultant with FICO, sits with Merrill Chandler to talk about the trends in business lending and business borrowing. They will also discuss how the blended score shifts and how lenders use this blended data to automate underwriting.
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Fundability And FICOWorld ’22 With David Smith
One of my favorite people in the universe is Mr. David Smith from FICO. We want to show you we are here in the innovation center at FICO World. We are going to cut to a more private venue to do the interview, but I wanted you guys to know that we are here, and I’m excited to be able to interview you about what’s going on both here and in the SPSS World via business credit world.
Lots of changes and things going on. Lots of innovation in the innovation center. We are glad to host Merrill and I know he’s glad to be here. We are looking forward to a good conversation.
I am with one of my favorite people in all the world and of course, my favorite person in the FICO lender universe, David Smith. Welcome back to the show.
I appreciate it.
We are at FICO, and the entrance we were in there a moment ago when we did the introduction. We wanted to come out here because it’s a little quieter. We are here to get an update, SPSS. What’s happening in business lending, business borrowing? More importantly, how blended scores and everything that are starting to shift, and how lenders are using this blended data in order to automate underwriting.
The big trend and most of the calls that I get are based on the need to make $100,000 loans and lower, faster, better, and stronger. It’s your mantra here because the FinTechs are killing them. The on decks and the cabbages have got incredible IT in investment to do automated decisioning off of all kinds of data. The banks are saying, “We were still working in this heavily regulated world. How do we do this better?” They come to us to get this SPSS score in order to use it as a tool to make better and faster decisions but not make anything risky.
The general trend is to ask for name, address, and serial number. I need enough information to get a personal credit report on the owners of the principles and get a DNV or Experian Business Credit report on the business. Legal business name, address, and phone number are gone and done. After that, if they do get cash information or financial information, they want it from the source. They are going to go into a platter to rip data out of your bank account because of what we found with PDP. The reason that banks are going to what we call an app-only or credit-only decision is A) It’s faster, but B) That data is credible. It’s been vetted.
There’s a third party looking at it. You can contest that information if you want. It’s bureau data, but it’s from other banks you’ve got credit with. The one thing we found is that the financial data that most small businesses have is frankly not reliable. You are a baker, plumber, and Uber driver, not a CFO, and that matters. That’s why you need to listen to Merrill about getting your financial data. It is important.
It’s not important for the $50,000 or $35,000 loans. It’s important for the $150,000, $200,000, or $500,000 loans. When you move to that next level where you need a building, heavy equipment, or something, you are going to have to produce financials, but most banks are going, “Most of our business isn’t in that. Most of our business are $100,000, $250,000, and less.” “How do I do this faster?” They are using your credit report. That’s why you need to listen to Merrill about improving your credit reports and that data. Make sure that data is clean and effective, and it’s serving you, not harming you.
The second trend is to find those small businesses. It’s a little bit of marketing, this, and that in order to glean these customers. One reason that FinTechs dived into PPP as quickly as they did and aggressively as they did other than the 3% to 5% fees is there was a lot of marketing to be done. The banks weren’t serving some customers. The FinTechs did. Who are the businesses loyal to? This is loyal to the FinTechs because they got approvals and the money. They survived because of those. If you are dragging me under the boat in the middle of somewhere after this big boat sinks, I’m loyal to you. It makes sense, but it’s also costly money.
Right now, 10% is an easy low FinTech compared to a 6% to 7%, even a court with the inflation rates. 67% on a small business at a bank compared to 10%.
Ten percent is generous. When you factor in fees and you look at an actual APR, there are some FinTechs out there doing 35% and 40% APR loans. They know business owners don’t have a lot of time in their life. You don’t have time to fill out a fifteen-page application. You don’t have time to go gather data from fourteen different sources, compile information, and dig up your old business report for a $15,000 loan.
When are you doing this? You are not doing this in the middle of the day when you are making money, running your shop, or driving your truck. You are doing it at night when you should be sleeping and spending time with your family. Probably your spouse and kids are asleep, even the dogs asleep, and the only light on in the room is a glow from the laptop. You are just regretting this. You then look on your Google search, and you say, “I can get cheaper money quicker from on deck.”
It’s a soft pull until you get approved.
That’s another thing. I can’t tell you how many banks have called us and said, “We need to start doing soft approvals.” That’s a big trend and that helps the consumer in the long run.
You can see that these are the terms. This is the right sheet. Do I pull the trigger or not?
On the inquiry level, everybody has got a consumer credit report, or at least most small business owners do. If you try to go out and get an auto loan, and you’ve tried to apply for 5, 6, or 7 small business loans, now you are being dinged on your FICO score because of income inquiries. They are like, “These two should not connect. My business and my personal should be separate.” That’s why banks are moving to a more soft pull, not even pre-approvals.
They are approving them with it. You have to get a hard pull to get all the data at some point.If you don't want to be a hobbyist, you have to treat your credit professionally. You have to manage it professionally. Click To Tweet
All the basic inquiry is the soft pulls.
I love that trend, but what we are coming to you and another individual in your workgroup, Glenn, is they are working on how to shift the overdraft modeling and quit penalizing individuals for the use of little temporary lines and turning them into actual credit lines.
Some people have personal accounts and overdraft line. An overdraft line or credit counts as a line of credit, but it’s a line of credit you can’t use unless you go negative in your account. The new FICO scores like the FICO10, FICO Ultra, and XD look at NSFs. If you are going NSF on your account, that’s hurting your FICO score.
They won’t give you any approvals afterwards for six months.
There’s a huge circular irony in this. What we are trying to convince people to do is don’t give them an overdraft line. Give them a B-LOC or a regular line of credit that can be allowed to account for the overdraft. If you do overdraft, you have it but also useful for other things. Personally, I’m not speaking for FICO here. A friend of mine came to me and said, “I got a Goodyear credit card.” It can only be used at Goodyear for every 50,000 miles.
Get a regular visa so you can get a higher credit limit like $2,500 and then put the $1,000 tires on that card and pay it off. Now you’ve got other credit you can use at the grocery store, to pay bills, to buy those fancy shoes, or go on vacation, or whatever you want. It doesn’t make sense to get isolated things, like the overdraft protection doesn’t make sense. We are trying to expand that access. Plus, if you could get an initial line of credit at your bank, you are going to be more loyal to that bank. You are going to go back to them and they will be in a position to know you from a credit perspective, and that 14-page application comes down to a 1-page application.
After a certain amount of time, we start raising those limits because your internal performance data is spot on, especially when we train you how to do it. My tribe knows how to do this, and then we are going to go to $5,000, $10,000, $20,000, and higher.
That’s what we are trying to do. We have had some good traction, but nobody has taken it yet. There is a lot of good traction on it from some fairly large banks. Once one domino falls, it is all going to fall.
The data will show how valuable it is.
The administration is pushing banks to do more with small businesses. The content of that side is the more banks do as small businesses, the more the government wants to regulate small business lending. The CFPB has a big interest in small business lending because the consumer report is part of that blended report, so expect that wave to hit the beach very soon.
It’s coming, but for me, it’s not a bad thing.
It’s not necessarily a bad thing. For the banks, it’s more regulation and additional personnel to manage things. In reality, it’s going to put some form and structure around small businesses.
The ROI and the products that they are forced to do if they are smart borrower behaviors, then they get to profit by these very instruments.
There’s a little bit of structure on commercial lending. There is a lot of structure on personal lending. When you fall in that intro-level small business or micro-businesses is another term they will use, the banks just kick you over to a personal loan of credit cards that manages that. It’s that mixing of credit that is dangerous for small businesses, especially if you want to be a legitimate business, not a hobbyist. If you don’t want to be a hobbyist, you have to treat your credit professionally. You have to manage it professionally. You’ve got to get an accountant or do it yourself, one or the other. Admit your faults or you are not good at something and get an accountant.
Share with them, as an entrepreneur, what you were doing on Fridays and no matter what end of the week required this.
I own a small business, and my wife owns a small business. She is horrible at filling out invoices. She will wait 3 months and then fell off 3 months’ worth of invoices and get a huge check, but our checking account does this.
That is not good behavior and doesn’t attract your lenders.
This can be whatever the end of the week is for you. It doesn’t have to be Friday. It could be Sunday or Saturday. Whatever your end of the week is, you take a certain number of hours from 2:00 to 5:00 if you are at 9:00 to 5:00-er. Whatever the end of your week is, take a certain set of 3 or 4 hours at the end of your week and get your finances in order. That can be an invoice, bill, order, or catching up on your books. Do what it takes to prepare yourself for the next day, week, or cycle.Don't upset your customer base by sending in three months’ worth of bills because they also need a cadence. They also need regularity. Click To Tweet
What do you need to do? Look forward. Closeout last week, “I worked with three clients. I did thirteen hours for each client. I need to send out bills on Friday afternoon.” Don’t work for free, and don’t upset your customer base by sending in three months’ worth of bills because they also need a cadence and regularity. Everybody loves consistency. Be consistent about that.
The reason why I wanted to share that with you is because I’m going to incorporate that into our trainings. Remember, if you are not getting regular deposits, your cashflow looks wonky. Wonky is not fundable. This is fundable. Even if this is fundable, this is not fundable.
That is a lack of professionalism. It shows that you are a hobbyist. From a lender’s perspective, you are not serious about this. Everybody needs to act like you are serious about this. Whether or not you are good at it, you got to look at it. Know your limitations. If you are no good at this, hire an accountant. If you can’t hire an accountant, talk to a friend or barter for it. Give away some service for a little advice on that.
It’s not rocket science, but it’s not easy either. It takes discipline. That’s why I’m saying Friday afternoons. At the end of your week, take three hours and get it done. If you wake up one day, you need widgets and you didn’t order widgets, you look in the bank account and you don’t have money for widgets, or you don’t have enough money to order widgets quickly because quicker widgets are costly, you are putting yourself behind, and that’s not good. Consistency and professionalism are going to grow your business more than anything.
You are hearing business borrower behaviors that are trackable behaviors both in your bank accounts is going to end up. Your P&Ls are going to be legitimate because part of the reason why lenders want to move more to automatic approvals is they don’t trust financials anyway.
You can’t rely on it. The smaller the business, the less reliable it is. The more they are going to interrogate you on, “Is this stuff true?” They can grab tax records, but again, tax records are wonky.
They are wonky because you have a great maximized top line.
You report to IRS, and you are not going to lie to the IRS. That’s more reliable, but it’s still based on that box of receipts if you are a box of receipts person. Garbage in, garbage out. I don’t care what document you put it on. It’s garbage. When you are in a regular cadence, you can say, “I spent this $20 on a business expense. Let me roll that into the expense.” It’s a write-off. You get to manage your economy within your business a little better because it’s fresh on your mind. If you are waiting 2, 3, or 4 weeks, none of it is fresh.
There are apps that can help you do this from an hourly management perspective. QuickBooks has tips and tools in it. You can go to certain accountants and they will give you, as part of their service, default reports that you can download into QuickBooks and produce reports for them, so it makes their job easier. Trust me. They are not doing it because they are friends. It’s making their job easier, quicker, and cheaper, and it helps out everybody. Some engage in that. Get in the habit of regular financing, especially if you want to get into that larger dollar loan.
Are you talking about $20,000, $50,000, or $100,000 above?
It’s more of $100,000 or $250,000. It depends on who you bank with. I’m going to say that I make money off very large banks, but I bank at a credit union. I love credit unions and community banks because they both act in the same measure. They are responsible for their members, customers, and communities, and they have services.
They have services that will help the business because if they see you fail, they are going to fail. They help. Maybe you look into changing banks, smaller or regional banks, not an ad service, but Renasant Bank. It’s a very good small business bank and they have services for small business owners. They have ways to save, apps, and connections to other systems that will help you. They have different types of businesses that they are tied into to help their small business owners. Bank of America probably has that, but you are going to get more advice at the community level.
Our QFE model has, for client companies, these tier three community banks credit unions. The tier 1s and tier 2s which is saved for the B-LOCs.
Odds are, especially, if you are looking at large dollar loans and your credit union might have to go out because credit unions are going to confine to what they can do commercially. Having 1 or 2 banking relationships is not a bad thing for business, but you want to have a primary and a secondary. Treat the primary, primary and the secondary, secondary.
Moving into 2022 FICO’s perspective, where are we headed for 2022 moving into 2023?
Expect some credit constrictions. If you are a B-minus credit rating, you might not get money in 2022- 2023. For BB, B-plus, A-minus, I’m not going to say it constricts a lot, but it will constrict because the economy is getting tight and you had one negative quarter of GDP. If we go to two negative quarters, that’s called a Recession. The R-word is dangerous and people freak out. Inflation is not pretty these days. They say it’s 8%, but if you go to the Carter era calculations, it’s more like 17% to 20% of what we think of as inflation. If you walk to your grocery store and gas station, you can afford it, but you know there’s inflation, and that’s hitting everybody. It’s not just the middle-class, the poor, and the businesses. It’s everybody. Expect some constriction on the process.
One of the metaphors that we use, or basically our number one symbol, is a target. We have the Cs and Ds out in the outer rings, and then bullseye is that A-plus. We talk about fundability is doing a scattershot, so no matter how big the target is, you are still a bullseye borrower.
Expect the target is going to get smaller. It has to get smaller. Also, if you qualify for an SBA loan, go for that. I don’t think those loans are going to be as constricted as possible. As you get into a recession, it’s important to make more capital available to lend to businesses because that’s how you get out of a recession. Seek out SBA loans and those banks that are prominent SBA lenders. FinTechs are SBA lenders but go to your bank on that. I’m not dissing the FinTechs because I’ve got a really good relationship with FinTechs.FinTech should be the lender of last resort. It should not be the first place you go for money. Click To Tweet
Build the relationship, but let’s also get the traditional bank to catch up with the web banks, neo banks, and FinTechs.
FinTech should be the lender of last resort. It should not be the first place you go for money. If you have to go to them for money, go to them for money. It shouldn’t be the first place, and banks are figuring that out.
That’s what we are collaborating on every step of the way to build in a way for banks. I always position it that FICO is working towards lenders from the top-down analytics and protecting their money. We get fundable. Fundability Inc is working from the borrower to the lender and improving those relationships, but the key to all of this is lender capacity to make the right decisions and nurture relationships with borrowers.
Right now, they are only going to make sure bets. They are not going to roll the dice on anything. The second big trend is medical debt. You don’t generally ask for medical debt. You’ll fill out an auto loan or credit card application, but nobody fills out a Billy broke his arm application. That bill comes out of nowhere and you may or may not be expecting it or pay for it.
Your insurance may haggle, you may owe money, and you find out after six months that that bill is already in collections. There are some new regulations coming down. The administration is doing some good things here, and I’m not totally against them. There are going to be some changes to your credit report as to what gets counted into your FICO score and on your credit report at all-around medical debt, medical collections, and such. Be on the lookout for that.
For those people with medical debt above the limits, you are going to see about a 25% increase in your FICO scores. You will see some improvement because you are being punished for something that wasn’t your fault. I don’t know if you’ve ever been to an emergency room. With the mess that insurance and bill pay, you’ll get a bill four months later from some doctor that walked by your room that decided to bill you $100, and it’s already in collections.
It’s that craziness that this is addressing. There’s a change coming in July of 2022. There’s a change coming in early 2023. If you are using the FICO 9, FICO 10, or 10T Score that already made some changes in medical debt, older scores like the one Fannie and Freddie use in that, the new ones do account for it. Once that data is off your credit report, every FICO score will reflect that. That’s one of the bigger changes in 2022. It’s what everybody is asking about.
It’s thrilling to be here and see you again personally. We are like brothers from different mothers because there’s so much synergy.
We are both enthusiastic about small business owners. I love small business owners, and I hate to see them fail. The last years broke my heart. You can tell those that were weakened got stronger, and they figured it out. Let this keep figuring it out for you. Solve one problem, then another problem, and get to that fundability level and get fundable.
Thank you so much. We have more coming to you from FICO World 2022. Have a great day and we will see you next time.