In SMB Lending, (More) Knowledge Is Power

For lenders and other firms assessing the credit risk of their SMB clients, knowledge is power. And data across the qualitative and quantitative realms ensures that a lot of knowledge can go a long way, especially in gauging those small businesses with little or no credit history — opening up, as LexisNexis Risk Solutions’ senior director of small business risk management Ben Cutler explains, a wider pool of potential new customers. 

Change is a constant in the small to mid-sized business world, and the need to track change is also a constant for the lenders to those SMBs. Beyond the changes in the economy at large, or the revenues or operating expenses generated in tax returns, or discrete data points that form the basis of a conversation between applicant and financial institution, tracking the risk status can be a challenge.

Earlier this month, LexisNexis Risk Solutions said that its suite of products geared toward assisting lenders with account management can help mollify this challenge through its Small Business Monitoring, which draws on disparate data points to assess risk in a proactive manner.

In an interview with PYMNTS, Ben Cutler, senior director of small business risk management at LexisNexis Risk Solutions, a part of RELX Group, an information and analytics firm, said that the monitoring tool takes its place alongside, and works in conjunction with, the firm’s identity verification tool, small business credit score and trade financing products.

The theme across all of these offerings, he said, is one of using alternative data, traditional data and technology to assess the risk of small businesses that are tied to a “small business information gap” that cuts across millions of small firms. The key is to take all of this alternative data, analyze it and then move it on up through credit scores and identity reports and then feed it back to the users. These LexisNexis Risk Solutions clients — including financial institutions, telecom firms and corporates using LexisNexis’ suite — said Cutler, are actively seeking new account acquisition and new customers.

“What we are seeing from our customers is that they need to secure additional [small business] clients to grow, but many of their applicants just don’t have a lot of information [about] them,” he said.

Only about half of small businesses, he said, have a credit profile or have a credit report on that business, with half of those, in turn, he noted, classified as “thin file” reports. These small businesses, he said, numbering in the millions, may not have the credit profiles seen with other firms, “but many of them have been around three, four or five years.”

And what LexisNexis seeks to do against this backdrop is look beyond credit experiences to help clients and lenders “understand a small business … to profile a small business,” using alternative data to build an identity and a credit score and monitor that firm for changes in risk profiles, both positive and negative.

Touching a bit more deeply on alternative data, the executive said that when small businesses are in their initial stages of formation, owners are rarely rushing out of the gate to get credit — rather, they are taking initial steps to get started.

“Many times, the small business owner will go get a telephone,” Cutler illustrated, “or some type of facility … or they’ll get a business license or have to get incorporated.” It is these non-credit footprints, he said, that a business leaves in the data environment that is proof positive that they are real entities, and they also offer up indications of ability to cover expenses. In other words, there exists information on transactions that have been successfully hurdled to start operations, yet are not related to credit.

These alternative data sources number about 10,000, said Cutler, and “when you are looking at 10,000 of anything, you have to have a lot of technology” to help sift through those data points. In drilling down into those data sources, said Cutler, some sense of risk factors emerge that are of value to lenders.

For example, if a business is active (and actively registered within at least one state), that represents about half the credit risk of a small business that is not similarly engaged. If there can be found a derogatory experience, he continued — such as an official complaint or judgment— that is three times the risk of a company that is not marked by such an event.

“If it is a recent judgment in the past 12 to 18 months,” he told PYMNTS, “that goes up to four times [the risk].”

As the data is aggregated together, algorithms are employed to identify the risk associated with each element, said Cutler. He says LexisNexis works with a large bank that helps provide the firm with a group of accounts and how they have performed over a given period of time, enabling LexisNexis Risk Solutions to go back and look at a point in time to assess “what did that small business look like and how would we have assessed the credit risk of that small business at the point of time? Then we fast forward” and look at the actual performance of that customer.

The most common scrutiny rests with what the track record of the small business is, said Cutler and, second, details about the person connected to that small business. Cutler noted that his firm’s clients are looking for information on derogatory experiences ranging from tax liens to bankruptcies.

“There is a maxim in the business that a small business is the person or the people behind that business,” he said. Looking through the alternative data, about one in three of businesses or the person who is connected to that small business has a derogatory experience in their background. The percentage “is higher in the person population than in the small business population,” he noted. “Many times, when a small business is in trouble, the owner closes the door, and he goes and starts up another business down the street that does physically the same thing but is avoiding the problems” that had been seen before.

The relationships are complex between the personal and professional, and telling, for credit risk. Cutler said the intertwined data is a key area of focus for his firm, as 40 percent of smaller businesses, with at least $1 million in revenues, mix their personal and business operations.

As might be surmised, when there is a derogatory element on the personal side, he said, that signals increased risk in the business.

The small business owners are “very loyal” and may stick with a bank once that credit is extended. Thus, said Cutler, many of LexisNexis’ lending clients want to establish relationships early with these customers.  The extension of credit, said Cutler, “is something of a business accelerator. Once a business has access to credit, it enables further growth, the cycle continues.”