Eight proven ways to minimize your community bank’s small-business loan risk
By William Atkinson
Loans, by their nature, represent risk. Small-business loans in particular can represent quite a bit of risk, but there are several strategies that community banks can employ to reduce it.
First, though, how are small-business loans in general faring these days? According to the Thomson Reuters/PayNet Small Business Delinquency Index, small-business loan delinquencies peaked in early 2009 at 3.4 percent, plummeted to 1.1 percent in early 2013, but have been slowly climbing since then, to 1.4 percent in early 2017 (the latest data available).
Forecast loan default
rate for small
businesses in 2018
Defaults are also slowly rising. According to PayNet’s AbsolutePD Forecast Default Rate Chart, the default rate for small businesses was 1.5 percent in 2015, rose to 1.8 percent in 2017, and is forecast to rise to 1.9 percent in 2018.
“Loans to small businesses are always risky to both the small-business owner and the bank,” says T. Alexander Spratt, president and CEO of Ardmore Banking Advisors, Inc. in Ardmore, Penn. There are several reasons for this. Local economic issues, such as large companies leaving a community, can hurt small-business owners’ ability to sell services or goods as people become unemployed. Furthermore, the increasing presence of chain stores and online shopping makes it more difficult for local small businesses to compete.
Spratt offers eight things community banks should look for to protect themselves when considering loans to small businesses.
1. A knowledgeable, capable owner. Look for an owner with experience in the business sector over time, either in other businesses or in his or her own business, as well as knowledge of how to run a business profitably.
2. Repayment from profits. Seek evidence of the owner’s ability to repay the loan from profits, not from collateral, which is a last resort.
3. Clean credit history. Examine the owner’s credit history for any signs of sloppiness or inability to repay debt in a timely manner.
4. Dedication. Evaluate the owner’s passion in his or her business, as reflected in his or her commitment and tenacity to get the job done.
5. A thoughtful business plan. Look for a business plan that matches reasonable expectations for revenue, costs and need for capital, and includes plans for how to cope with the unexpected.
6. A comfortable amount of capital. Too many small businesses are stretched thin and have no room for error or support of growth.
7. Collateral. Collateral does not make a bad loan good, but it can mitigate a loss by a sale in liquidation.
8. A personal guarantee. This is another necessary and secondary repayment method that helps but does not always provide repayment if the company and loan fail. “A personal guarantee does motivate the small-business owner to repay the loan from company revenue, though,” Spratt says.
William Atkinson, a longtime Independent Banker contributor, is an Illinois-based journalist specializing in banking and