Scaling Your Loan Origination Process to Win at Small Business Lending

Mitch Woods: Well, thanks for joining us on today's episode of Lending Made Easy. Today we've got David Catalano and Bryan Peckingpaugh, and we're gonna be talking about scaling your processes to win at small business lending. And I'll just kick it off with a question. So Bryan, David, whoever wants to take this one, how should a bank or a credit union approach a loan for a small business versus one for a consumer or even a larger commercial deal?

Bryan Peckinpaugh: First and foremost, you gotta look at how are you winning in that particular segment in the markets you serve today, because that'll tell you a lot about where you should focus and you know how you should differentiate. Very broadly speaking, you're gonna find that, in that space, speed wins.

But you also have to define what you mean by small business, is that, something you're stratifying by the size of the business, the size of the exposure to the organization, because that line can get grayed inside of an organization between, what is traditionally called small business versus what is called commercial. And products overlap the two all the time. They can be very similar structures no, matter which, segment you're talking about. and we even talk to clients in our portfolio about, the idea of just small commercial instead of small business because for just definition of terms sake, here at Baker Hill, when we say small business, we're talking about those loans that are scored and auto decisioned, where you're primarily working off of an actual score, whether that's an SBSS, an IPV2 or something of the same ilk. So you gotta bring all those factors into play and then look at, you know, what does that mean for your institution and what are you ready for from an adoption perspective. But again, it will always come back to, in that particular space, when you're talking about the business focused loans, for smaller sized institutions, speed will win because when they need the money, they need it now, because it's usually something that's critical to keep their business operational right? Making payroll, buying a new truck to support their business cuz their old one died. they usually aren't borrowing money for something that can wait.

David Catalano: Yeah, I think all those are really good points Bryan. I like to think about the full underwriting process where you're spreading and you're doing a credit memo and there's a decision body that's making that credit decision looking at the data. Versus where you have less credit risk, so you have a smaller sized exposure and you're making those decisions much more quickly without doing cash flows, without looking at, you know, a deep dive in the business.

You're simply looking at a score, typically of the owner and of the business, and then you're making a decision based on there. And to the extent you can do that quickly. And you can develop a reputation in your community or in your niche cuz I've seen this niched in a wider area, like in the dental industry I've seen it niched many times by many different institutions. You can grow a reputation in that space and really attract a lot of the same types of deals. And if you're comfortable with those credits, you can really, originate quite a few loans. If you're underwriting them in a quick way because you understand the risk of the industry, the risk of the underlying use of proceeds like equipment, as an example in a specific niche industry, and then you just wanna document those quickly.

You just don't wanna spend a whole lot of time dragging that borrower through a process. Now you can also charge a bit more for that. So speed. with speed, you pick up a bit of yield, bit of rate. You might pick up some risk if you're unfamiliar with the industry, but I did niche lending for years and it's not risky if you understand it and you understand what those risks are and mitigate those.

So it becomes, you're, I guess maybe there's a familiarity element to it, but you end up developing a reputation for speed. And the place to go for that asset. So I would encourage people to be thinking about that. Many of our clients are generalists and they're handling, you know, smaller loan sizes across the industries, across the board cuz they're serving a community and that's okay too. Right? 

Just understanding the risk that you're taking and being able to score those. And some of the scoring that's done today, it's been around for a long time. It's gone through recessions. it's worked historically, and should continue to work and if you talk to the people at FICO about their business score, you know, their claim is that you can go up two a million dollars on a score and you may very well be able to do that.

I don't know any banks that are comfortable going that big on a score, but half a million for sure. and 250, absolutely. And 100 is, you know, typically not a problem. So I would encourage folks to think about scoring, speed, building a niche, picking up yield. you're gonna need some technology to do that.

And then, we should probably talk about the gray area, Bryan. You know, it's easy to look at a score and say you're approved or another score and say, Hey, I'm not touching that deal, but what? But the ones in the middle, how are we gonna process those, maintain our speed and reputation and not miss out on a deal because of some element, there's some gray area in there we need to take a look at how we're gonna approach those at scale with speed.

Bryan Peckinpaugh: Yeah, I think that gray area is definitely critical. David, and I'm gonna piggyback on a couple points you made. First, we tend to talk about speed in almost kind of four speed sake, that fast wins and it's true, but there's also a corollary with that and that is with that speed also comes predictability.

So the ability for the loan officer or the RM, whatever fills this role in your organization to say, once I get to this point, we will close in this amount of time. It is almost, equally as valuable as the speed, so that predictability on behalf of the borrower, cuz they're likely, , shopping for these financial services.

So they'll look at a guarantee of a close date. As almost as important as how fast that close date is, knowing that there could be bumps in the road with any given lender. So if I know I can close by next Friday, I may take that over somebody who says, well, I think maybe I can close you on Monday. You know, because that's within a reasonable amount of time, and I'll take the predictability. And knowing what's ahead of me. You also talked about the scores, David, and you know, FICO and Experian, they, like you said, have been doing this for a long time and this will bleed right into that gray area because you have to look at how those apply and how those tie out with what looks good for your financial institution.

Those are broad scores across a lot of different factors, verticals, markets. Locations in the United States, et cetera, you know, all kinds of, all kind of comes together into those scores. so you don't wanna just go blindly into it. You wanna make sure that what your selected score provider gives you is as a raw number actually ties out with what you see in your portfolio. What is performing well and how does that tie to scores? And that means you gotta build up a little bit of history on this. So there's value in applying a score as part of your origination process before you move to auto decisioning.

Building up some period of time where you can look at it and say, where did I make yes and no decisions, and what were the scores in those instances? And that is what drives this gray area, David, that you're talking about. It is very easy on a very high and low end to weed some out or say yes to some, but the bulk of it's gonna fall in the middle somewhere.

And what you have to be very careful of is, people questioning either side of that transaction. So your folks who are responsible for production by nature are gonna question the auto declines. They're gonna give you all kinds of reasons. I went to school with this small business owner. My dad knows his sister's, husband's, boyfriend's cousin, whatever it might be. And, you know, thus we should have given him this loan even though the score was low. On the flip side, you're your folks responsible for the risk and the credit side are gonna look at it and say, We shouldn't have said yes to this because, you know, this particular niche like you were talking about David, is going sideways or, hey, I see that there are some extenuating circumstances, maybe some collateral, but I don't believe in the value of it.

That factored into it along with the score, and so I think we should have declined it. And the more you have that, the more you erode those hard and fast yes and nos, the less value you get out of a scored process and so you have to be very careful with the overrides of what the system says you should and shouldn't do.

So that means you, you have a automatic yes, your gray area in the middle, and your automated no on the bottom, and you wanna be slowly moving those levers and tuning those levers to hone in on the gray area that makes sense for your financial institution. because the last thing you wanna do is put a process in place for scored based lending and have the people question it, and thus they're going back and looking at those credits that they never should have looked at due to the score and then you're losing the efficiency play that's associated with it.

David Catalano: Yeah, I agree. It's important to understand that the human cannot process what the machine is processing. They're gonna see two different. They're gonna see two deals and they're gonna see them differently potentially than the machine. we have to make a decision. Are we gonna be with a machine or are we gonna score, or are we gonna,have a person look at each one of these things. And we already talked about the importance of scale, which leads to predictability, which leads to more production and happier RMs relationship managers, happier customers. And if you're sourcing your deals from equipment vendors around town, which, we did historically when I was lending, they like product.

Predictability as well. They like to know, hey if I send a deal over to Dave, it's gonna get done and I'm gonna have a decision today. I'm gonna have it docked in three days. They're gonna fund me next week. it's straightforward. Predictability is key. And with all of that, you pick up yield. Now there's one more element that I think is important to talk about and you know, we're talking about automating the front end of this process, the origination component of the process.

And if we're gonna put, lots and lots of credits on the books and we're not gonna underwrite them, then we need some way, I believe, to monitor them. And that gets into portfolio monitoring, which is essentially automating the backend. So you've got all these loans on the books. You probably have a deposit account for a lot of them.

And deposits are a leading indicator of the health of a business. So you can monitor, deposit, account, balance, changes month to month or whatever time period is appropriate. You can monitor, loan payments for, delays, delinquencies, lack of payment, and basically collect that data over, 260 times a year every night that you run the core. We pull new data in and we run those rules If nothing triggers, it's probably still a good loan. You don't need to do anything with it. But if some triggers occur, especially a series of triggers, then you're gonna wanna assign somebody to that and go pay a visit to that small business that you've loaned a hundred thousand dollars to. So it's just a way to automate the back end, just like you're automating the front end. Make this efficient for everybody. Bryan, what are your thoughts on that?

Bryan Peckinpaugh: There's a lot of great technology that you can apply front to back, but before we, we wrap here, I think it, it is important to circle back to that definition of small business. You know, we've talked a lot about our definition, right? Which is this score based full automation, which I think is important, but not every institution is ready for it yet.

And when I am out there talking with clients, when they start the conversation with, we're looking for solutions for small business, the more you kind of do discovery with them, you unwind what they're asking for. The more you find that what they're really looking for is efficiency of small credits and that can be a very interesting kind of diversion from this idea of small business because those small credits may well be for your largest commercial clients.

It may be a very large commercial client that is asking for a, small $15,000. Credit of some kind. It could be an equipment, it could be, some kind of unsecured bridge loan. You know, who knows? they just need $15,000. And you can look at other factors like how much of their deposits do I have in the institution?

How much is my aggregate exposure compared to that? There are a lot of factors, that can come into play to try to quickly and easily make. Those decisions on small dollar amount transactions, and that's usually a good place for these organizations to start, and that can be as quote unquote simple as, leveraging your existing commercial LOS, so long as it, it has a dynamic workflow component to it. To have a separate workflow for those smaller credits. I don't need to underwrite a $15,000 credit for a large existing relationship the same way I need to do a 15 million new relationship. And if you have a commercial LOS that can differentiate between those two that can give you different experiences based on what it is you're trying to accomplish. You can solve for a lot of what we've been talking about inherently, and that may even be something you can do on your own if you've got, you know, configurable ability within that platform so I can build out a new workflow for loans under X dollars, right? and use some of those same principles that we're talking about.

To ensure those go through a much smoother process, deliver a better experience, not just to, the borrower, but also to the RM that has to work that loan where you're not telling 'em they've gotta go get three years of financials and, double check that you got the articles of incorporation and get get everything that you would for a new relationship that maybe you look at it and you go, got everything we need, Mr. Or Mrs. RM, we're all set to go. We'll have you docked and closed in the next, five business days or something like that. and so I think that's important to look at too, is when you're a financial institution trying to solve these problems, what is the real problem you're trying to solve? You may call it small business, but you may find that it's actually small credits regardless of size of institution, that you have to win with speed and win with experience so as to keep the large relationships you have happy.

Mitch Woods: Yeah I think some great insights from both of you there. And David, I like the fact that you brought up even scaling the backend of the loan origination process there and monitoring the portfolio. And one of the things that I'm taking away that I think anybody could is no matter how you define small business, whether that is a true small business or it's just small credit, both of you brought it up, speed's, key speed's critical. And it's all about using the technology and the data at your institution to really fine tune that decision process, whether that's on the front end or on the back end of the origination process. So Bryan, David, thank you guys both for your thoughts today and your insights. And thanks everyone out there for listening to today's episode of Lending Made Easy.