Keeping Small Business Afloat While Addressing Risk

How financial institutions can make a long-term positive impact on the U.S. small business market

Gonzo bankers, we are facing events that will cause an immediate impact on the small businesses in our communities and in our portfolios, and now more than ever we need to show our stuff!

Whether or not an institution has a formal small business credit portfolio, it likely has exposure to the small businesses in its market area. While the events that will produce this inevitable spike in credit issues are not the same events as those that produced the credit problems in the first half of 2009, the events of today are definitely going to lead to significant credit problems for small business clients over the next several months.

One thing is certain: banks MUST act and act quickly. Starting immediately, small business leaders need to:

• Triage the current credit portfolio
• Create a response strategy for the current portfolio
• Bring new loan application and deposit account opening online

Triaging the Current Portfolio

Overall, bankers’ triage efforts should result in each relationship falling into one of four categories:

• Group 1 – Credits that were already bad/going bad and current events will just accelerate their move to failure/credit loss
• Group 2 – Credits that were teetering but the current events will only serve to force them down a path of failure
• Group 3 – Credits that were operating just fine but the events of today will move them into Group 2 (at best)
• Group 4 – Credits that were operating just fine and will continue without a problem. They will feel some pain but nothing they can’t handle.

For larger commercial relationships, it may be acceptable/appropriate to take a very manual approach to categorize each relationship, but for the small business relationship, such manual processes are slow, cumbersome and ineffective. Rather than just beefing up the reserves or spending an exorbitant amount of money that only serves to cost the financial institution more than the likely charge offs, a smarter triage approach can be taken. Specifically:

• Perform a batch rescore of the entire small business portfolio with one of the business credit scorecards (e.g., D&B, Experian, PayNet, SBFE). If you haven’t segmented, just rescore the entire commercial portfolio.
• Identify the commercial/small business relationships where you have both a loan and deposit relationship.
• Banks that only have a credit relationship with the small business are at a severe disadvantage and will be flying blind.
• Institutions with both credit and deposit relationships have a distinct advantage in completing the triage process.
• Gather the data of the small business portfolio on the following behaviors:
  • Delinquencies for the past 12 months
  • Line utilization for the past six months (for those relationships with a line of credit)
  • Average monthly deposit balances over the past six months

At this point, it is not critical for the information/data to be precise. The bank should do the best it can in collecting this information. Once it has grouped the relationships, the focus turns to developing the action plans for each segment.

Segment 1 – Already gone

While harsh, the reality is that not much can be done here. Refer to Special Assets and move on.

Segment 2 – If only this hadn’t happened

If the obstacle wasn’t COVID-19, it would probably have been some other type of unforeseeable event. Regardless of the obstacle, the odds were against this group and it has to either come up with its own remedy or be kept afloat by some government bailout for the next several months.

Segment 3 – It’ll be OK with some short-term support

This group will likely bounce back just fine as long as they can make it through the next “however many months it will take.” These businesses were building their net worth and their strength to withstand the typical economic cycles, but then COVID-19 hit, swiftly and suddenly, and it was nothing they could have anticipated. These are the businesses that will likely survive with just a little bit of help. More importantly, this is the group that doesn’t have to fail and cost the bank double-digit charge offs. They will be EXTREMELY loyal if the institution helps them through this time of crisis.

Segment 4 – I’m sorry others are being negatively impacted but I’m OK

These are the easy ones. These businesses have significant cash reserves or are in an industry on which the impact of COVID-19 will not be significant to their overall success or financial condition. Banks are fortunate to have them in their portfolios.

Response Plans

It is the response of these financial institutions that will be the most difficult and beneficial to the FIs and obviously to the small businesses in their markets.

Actions to be taken:

• Facilitate use of the Government Relief Package (or whatever they end up calling it).
• Be an expert on what is or will be available from the government. We know something will be passed, eventually. The lending and credit teams need to be on top of what is available and guide small business clients on how to take advantage of it. This communication must be consistent with a “paper trail.”
• Be prepared to offer “bridge” financing until the monies arrive from the government – assuming guidance will be conducive to this structure.
• Provide support by purchasing small business goods or services. Buy directly or buy gift cards, but just buy to put some money in their accounts to help the small business client survive.
• Assess the likelihood of default and the subsequent likelihood of credit loss for the small business relationship. Given this potential loss, banks have to make a call on what would be an appropriate/acceptable short-term hit to revenue to avoid a larger, long-term hit in the form of a credit loss.
• Provide access to professional advice. The institution has small business/commercial relationships with professionals that can provide guidance/advice to its small business clients in Groups 3 and 4 to help them get through the COVID-19 crisis, but they need to know who’s available. The FI may even go so far as to “buy” these professional services and make them available to its small business client base. As with the other actions, this will build goodwill as well as help a small business survive in the markets the institution serves.

There are a number of other strategies and tactics that will evolve in the weeks and months ahead that may/will be the result of this COVID-19 crisis facing the country. One thing is certain: if an institution does nothing, it will see a significant loss in the small business segment.

Adjust the Underwriting Criteria for New Applications 

Credit requests will continue to come and, unfortunately, there will be a lot of small businesses just trying to stay afloat, pay their employees and meet their obligations. They will be submitting requests for financing. Such requests will likely be a result of the institution’s current response to the COVID-19 economy.

Rather than just shutting off any new loan applications to avoid taking on problem loans of other FIs, banks and credit unions will need to adjust their underwriting guidelines to adapt to new economic conditions. The best approach is to leverage what was discovered during the portfolio triage efforts.

From the credit profiles defined in triage, each group can modify its underwriting criteria and potentially approve new loan requests. The probable candidates would be the categories 3 and 4 as defined above – those that will need some assistance through the COVID-19 crisis (Category 3) and those that are doing fine and will continue to do just fine (Category 4).

The question on the table for all banks and credit unions is this: Will you just watch the credit challenges unfold, or will your organization be one of those that takes action to help important small businesses continue to operate and extend the credit along with opening new deposit accounts that will make an intentional, significant and long-term positive impact on U.S. markets?