Alternative Data Gives Lenders Better Insight to Small Business Finances

These are tough times for small businesses.

Enigma Technologies Chief Operating Officer and Chief Product Officer Scott Steinberg told PYMNTS that economic uncertainty is not only making capital harder to come by for small- to medium-sized businesses (SMBs), but also more expensive.

“Interest rates are rising across the board and affecting the entire industry,” he said. “The cost of capital is going up, the opportunity cost of that money being invested is going up, and so small businesses are being hit with much higher interest rates.”

There’s pressure on the lenders too — if not at the moment, then down the line. Steinberg noted that there has not been a notable change in delinquencies, at least not yet.

But as they say on Wall Street, perception is reality. And the “perceived” risk of lending to SMBs has been growing, so lenders are growing more conservative in their underwriting efforts.

Small business lending occurs across several channels — spanning everything from small business credit cards and lines of credit to term loans to merchant cash advances and revenue-based financing. And, as Steinberg observed, overall approval rates are starting to inch downward, although they haven’t dropped dramatically yet. Even some alternative lenders (like Upstart) are suspending SMB lending efforts entirely.

“There may be some major changes ahead as people pull out — and there will unfortunately just be less funding available,” Steinberg said.

Perceived Risk vs Current Risk

Steinberg was quick to point out that perceived risk does not necessarily equal current risk. He stressed that data — and especially alternative data sources — can give lenders more certainty that the firms they underwrite will weather macro headwinds, pay back the principal and handle the interest charges too.

Historical data, said Steinberg, has not been an accurate determinant of current financial health. Historical data — whether a company pays its bills on time — is valuable but is a lagging indicator.

“What people want to understand is: What is the current health?” said Steinberg.

That means getting a sense of current revenues, current loan obligations and what the ratio is between the two.

Steinberg said new data sources exist to give lenders this visibility. One approach is pulling in bank account and merchant processing account information. Another approach is working with data providers like Enigma. By working with a large subset of credit card transactions, Enigma can tell lenders what the top-line revenue trends are of a business and how stable they are.

Card-Based Revenues in Focus

Such granular and real-time insights can serve as adjuncts to traditional signals of distress (such as high debt-to-income ratios), he said. Card-based revenues vary depending on the vertical but can be a strong indicator of distress or health.

Consider the example of a retailer that has typically had credit card transactions every day. If suddenly that transaction flow starts drying up (sales are only occurring every other day, for example), or there is suddenly an increase in returns, the warning signs are there. Benchmarks, he said, also offer insight into how that retailer, restaurant or salon should be performing.

For the lenders, being armed with the right data means being able to manage risk more efficiently at a portfolio level — and to take proactive steps to help protect the capital deployed and the borrower too.

Steinberg noted that “the best small business lenders tend to take the approach of really wanting to partner with the small business. They’re passionate about helping small businesses.” By reaching out early during times of distress or uncertainty, they’re able to restructure loans or payment terms to weather the storm.

Advanced analytics, coupled with new data streams, also can boost lenders’ approval rates, which currently stand at a low 20% level when done through traditional means. Data science, he said, brings lenders’ marketing and risk teams together to pre-qualify SMBs more efficiently.

“The best lenders aren’t just focusing on the risk side,” he told PYMNTS, “they’re focusing on identifying the healthy businesses that will wind up being their best customers.”

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