SBA credit scores to speed loans- System will help businesses gauge chances

When hopeful entrepreneurs approach Accion Chicago for business loans, they are worried about one thing: will they get the money?

By:
Joanne Cleaver
Chicago Tribune

Anything that eases their anxiety and helps them understand why they get–or do not get–a loan is a step in the right direction, says F. Leroy Pacheco, president of Accion Chicago, an agency that channels Small Business Administration microloans to fledgling companies.

That is one of the reasons he applauds a new effort by the SBA to create a nationwide credit scoring and modeling system, based on the SBA’s experience with its guaranteed loan program, that will help entrepreneurs quickly size up their chances for reeling in the cash.

The end result for small businesses is that when they apply for an SBA-guaranteed loan, they will get a credit score for their businesses similar to consumer credit scores.

"It’s like a report card for your credit," says Pacheco.

Scores will make it easier for business owners to shop around to different lenders for good loan terms.

Lenders benefit, too. Scores help them thumbnail an applicant’s creditworthiness, and that speeds up the loan decision.

For years, credit scoring agencies have created scoring models for big lenders that specialize in small-business loans. The models are expensive to operate and only very big lenders, especially big banks, have been able to buy them.

The SBA’s project, though, will be based on one of the biggest groups of small-business loans ever: its portfolio of 336,755 guaranteed loans. The resulting scoring models are expected to create a generic standard that can be used by lenders of all sizes.

All credit scores–consumer and business–summarize the borrower’s history of paying back loans. All kinds of credit relationships feed into the score: credit cards, leases for equipment and vehicles; bank loans and lines of credit; utility and office rent payments; and trade credit extended to businesses by suppliers for such things as raw materials.

Most small-business owners don’t really care if banks use scores or not, so long as the bankers make up their minds quickly, says Judy Delbovo, senior manager of business banking for Harris Bank.

In the seven years that it has been using its own internal scoring models, Harris has trimmed its decision turnaround time to a mere two days. Scores make loan approval or denial quick at both ends of the spectrum, says Delbovo.

"We use scores to identify applications that are absolutely slam-dunk approval," she says. "And it helps us identify the applications where there’s not a whole lot to do for the person, if they have a bad credit history or poor cash flow. Then we can concentrate on the middle piece, where we will always use our expertise in lending to identify the different kinds of credit we might be able to bring into it–the SBA, assistance from a loan pool, a state program."

Traditionally, smaller banks are more amenable to working with small businesses because they are willing to take the time to get to know the companies, their histories, and the owners’ character.

When a credit score is iffy, bankers often rely on their gut instincts to decide whether to make the loan.

If most banks start to rely on the new SBA scoring models, bankers will have to fight their gut instincts and rely on the scores, says Rick Frommeyer, a leader in the vertical markets segment for Dun & Bradstreet.

Dun & Bradstreet and Fair, Isaac were hired by the SBA to create the scoring models; the project’s deadline is September.

When a bank starts using scoring models, bankers have to think differently.

"There’s a fundamental thinking change on the part of the credit manager," says Frommeyer. "Scoring helps them depend on a score that’s derived from a statistical model that they may not understand. It may indicate that they have to ignore their instinct and trust the score. They need to be comfortable with the fact that the scores are statistically proven and that over the course of time their risk will decline if they follow the model and trust the scores."

Predictive model

As SBA lenders get used to using the tools, they will also start relying on the way the scoring model predicts which potential borrowers are good bets and which are likely deadbeats.

In the past, credit scores have mainly been used to summarize a borrower’s credit history. Predictive models spin out warnings based on certain borrower behaviors–like late payments.

The plan is that SBA lenders will use those computer-generated warning signs to signal trouble ahead and take action, such as meet with borrowers to find out what is going on with their business.

Of course, the predictive aspect of the scoring models are only as good as the bankers’ courage to use them.

"If you have a customer who has been great in the past, but you get a score that indicates that there is trouble ahead, what do you do?" asks Frommeyer. "Are you prepared to take action, or modify how you are managing [the loan]? It’s challenging for the credit manager."

Bankers are aware that it’s up to them to carefully explain decisions made on the basis of credit scores.

"We don’t say to a customer, `Whoops! Your credit score is bad. That’s why we didn’t approve you.’" says Harris’ Delbovo. "If an applicant asks why they were turned down, we’d explain the factors, not just show them the score."

Personal relationships

Small businesses consider a good personal relationship with their banks a top factor in their overall banking satisfaction, say Robert F. Neuhaus, a principal with Greenwich Associates, a Connecticut consulting firm that monitors small-business banking issues.

More small businesses are shifting to regional and smaller banks precisely because they think that is a way to get to know the bankers, he said.

"When the [credit] score is acceptable, it should not be a problem to get a larger bank to do the loan. If you have a `story credit’ that doesn’t fit the model, the community banks are more eager to work through those stories," he said.

(A story credit is a situation in which the business’ credit history needs explaining and doesn’t fit neatly into standard credit score categories.)

Business owners’ loyalty to banks who serve them well might also complicate the emergence of a national secondary market for small-business loans. SBA officials say that the generic scoring models they are having D&B and Fair, Isaac develop are a key building block in the development of a full-fledged secondary market.

The SBA has been packaging and selling portfolios of guaranteed loans since 1999.

When banks sell their loans, they get back money to lend again. The loan payments are managed by a servicing firm, not the bank. Some small-business owners might see that process as weakening their relationship with their bankers.

SBA officials say that there is no driving demand for a secondary market now, but add that such a massive undertaking has to be carried out regardless of momentary market conditions.

"You see that increasingly, with public markets becoming much more important, if the need arises, you have to have the secondary market in place," said Charles Ou, a senior economist with the SBA. "You can’t just make it up on the spot."

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Figuring out costs is critical in starting a business

By:
Dory Devlin
Newark Star Ledger in NASVF.org

Business has been light since the Strong Winds Consignment Boutique opened six weeks ago on Washington Street in Bloomfield. But the owners figured a slow beginning into their start-up budget.

"We knew from our research that the summer months would be slow. August more so," says Tyris Henry, co-owner of the shop with Gioya McRae.

So far, their projected start-up costs have been on target, except for one: renovations of the former pizza parlor that closed a decade ago. It cost $22,000, $2,000 more than budget.

"We did a lot of research, and it has paid off," says Henry, a network engineer who was downsized from Prudential Financial in May 2002. "We didn’t go into this blind."

Figuring the costs of starting a business as accurately as possible is the first critical step in starting a successful venture. Solid numbers are the crux of a viable business plan, which you will need to chart your course and to secure financing at some point.

There is no cookie-cutter approach to calculating start-up costs because every business is different, says James Almeida, assistant professor of entrepreneurial studies at Fairleigh Dickinson University. Fortunately, there are several tools and sources to help you get hard data and reliable numbers, but don’t rely on only one set of them.

Like the ’90s Chicago Bulls basketball champions, think triangle offense. First, draw on the experience you ideally have in the arena you want to enter. Write down the expenses you know, but don’t leave anything to guesswork.

Second, do market research. "Talk to customers in the channel line — distributors, retailers — to see where you would fit in the supply chain and the value chain," Almeida says. While you are getting price information you will also be establishing business relationships.

Third, mine industry reports and sample financial statements of similar businesses. The Small Business Administration’s Business Information Center in Newark is a good source for average revenue and expenses information on several industries in New Jersey.

For sample income and financial statements, check out the Risk Management Association (www.rmahq.org) and bizstats.com, suggests Denis Rasugu, a counselor with the Small Business Administration’s Small Business Development Center at Rutgers University in Newark.

Check the latest U.S. Census information (www.census.gov) to find and define your customer base. While you can find a lot of information online, go to a good library, too. A knowledgeable reference librarian can help you track down the industry statistics you need, Rasugu says.

"The biggest mistake a lot of entrepreneurs make is they don’t do their research," Rasugu says. "The key to a good business plan is good information."

With numbers from three source streams, you can arrive at some reasonable cost projections, which you can plug into some helpful online worksheets. The SBA recommends the Business Know-How Start-Up Calculator (www.businessknowhow.net/bkh/startup.htm) and the Palo Alto Startup Cost Estimator (www.bplans.com).

The calculator will guide you to separate costs into fixed costs and variable costs. Fixed costs are one-time and ongoing expenses essential to the business, including rent, utilities, insurance, while variable costs include inventory, shipping and packaging costs, advertising, sales commissions and other expenses related to the sale of your product or services.

Be careful not to mix up the two, a common mistake, Almeida says. These numbers are the basis of the income and cash flow projections in your business plan, and the break-even analysis to find the point when revenues will equal all business costs and profits begin to appear.

Here are a few other tips:

# Don’t estimate. Even if you have a strong knowledge of the industry, use real, market-based numbers for each expense.

# Time, times two. Getting a business up and running always takes twice as long as you budget, so avoid the temptation to make the numbers look more attractive than they are. Underestimating costs and overestimating revenues will not help your venture’s chances.

# Don’t underestimate what it will take to draw customers to your product or service. How long they take to come around will affect revenue projections and marketing expenses. "Entrepreneurs have a tendency to exaggerate the importance of their product and the easy acceptance of it in the marketplace," Almeida says.