How the ‘New Normal’ is Driving Change in Small Business Lending

The Paycheck Protection Program showed bankers they could drive more commercial lending via digital channels. Shifting in that direction may help community lenders especially find a home for surplus deposits.

As the Chief Strategy Officer at a bank digitization startup, I am constantly talking to community bank executives around the country. These folks have varying comfort levels with digitization. Some are excited to drive innovation within their organizations, while others are more conservative due to decades of deep-seated methods at their institution.

Several common themes come up in these conversations. Most executives I’ve connected with seek to diversify their balance sheets, leveraging cash on hand and enhance their commercial lending offerings with technology in some form or fashion. Whether they can do that depends on several factors, including local market demand and the current impact of digitization on commercial lending as a whole.

The Market: Community Banks Are In A Great Position

By and large, the pandemic left an mark on community banks’ balance sheets that can’t be ignored, even though the executives I’ve talked to are ready to move on from Covid. Notably, deposits are at record highs. Banks and credit unions have plenty of cash on hand. And the beginnings of a wave of bank consolidation is creating an opportunity for growth in many regions of the country.

For community banks, this is compounded by the fact that most of them outperformed the mega-banks in distributing PPP funds. Around 45% of the PPP funds were distributed by banks below $10 billion in assets. This has put community banks in a very strong position, while creating goodwill from businesses who appreciate that their local bankers supported them when they needed it most.

But, the road to success is not without its own challenges. Notably, commercial real estate (CRE) — the backbone of many community and regional banks — has been negatively impacted by the pandemic. Big CRE categories are still reeling from the adoption of remote work. And digital capabilities, viewed as table stakes by most banking customers, are generally not cheap to acquire. Banks like JPMorgan Chase and Bank of America have annual IT budgets that exceed the assets under management of most community banks. All that said, most bankers believe that the future is very bright for community banks.

Lending: SBA Programs Gain in Popularity, Awareness

Across the board, most of the bankers I’ve talked to are focused on diversifying their loan portfolios. They’re looking at opportunities in commercial and industrial (C&I) loans as well as expanding their use of Small Business Administration (SBA) government lending programs.

On C&I lending, one of the challenges banks speak of is fixed costs: They use the same processes to underwrite a $50,000 loan as for a $5,000,000 one. And they know this is clearly not scalable or efficient. But for banks familiar with CRE lending where a physical building secures the loan, diversifying means developing new processes to support lending against equipment or vehicles, and new products to be developed for working capital lines or credit or commercial credit cards.

As a result, many banks are looking for partners and technology solutions to support their efforts to efficiently offer new commercial lending products. Digital lending platforms and loan origination solutions are seen as an enabler of portfolio diversification within these banks. Following on from the success of PPP, every bank predicts that there will be more interest in SBA lending. They also say there will be more competition as more banks and fintechs start offering SBA loans.

Really There to Help:

SBA lending is seen as one of the ways the banks can further diversify portfolios. The indication is that SBA lending programs like 7(a), 7(a) Express and 504 (commercial real estate) are significantly more popular than in previous years.

It appears the reputation of the SBA as an organization that’s “here to help” has improved along with awareness of the government entity. One bank I spoke to had a single SBA Loan Officer before the existence of the PPP. They’ve quadrupled that number and are not planning to reduce it post-PPP, given that the volume of SBA 7(a) lending has increased. This appears to be a sign of things to come for many institutions.

Untangling ‘Digital Enablement’ and ‘Self-Service’

Across the board, bankers view digital as an enabler of commercial lending that is somewhat untapped at the moment. However, one of the challenges within banks is the separation of “digital enablement” from “self-service” — and more specifically, the fact that one doesn’t imply the other.

Leaving Past Practices Behind:

Many banks still worry about the complexity of commercial lending and the importance of banker interaction with the client. They don’t want to lose the human touch in a self-service world. But everyone agrees paper is not their friend.

Paper is bad for the client experience and bad for efficiency. The PPP demonstrated how digital lending can work in business banking and created an expectation of convenience and efficiency among businesses.

Crawl, Walk, Run Your Way to Implementation

The move to digital lending, self-service and automated decisioning can be scary for traditional banks. That’s why it’s important to crawl-walk-run. We’re seeing banks adopt a staged approach, beginning with smaller dollar loans to existing customers, and then expanding to larger dollar loans to existing customers followed by new customers. This allows the bank to build confidence internally whilst managing the perceived risk.

For most banks, the training wheels were ripped off by PPP. A bank president explained to me that they used their digital capability to underwrite loans from $40,000 to $8,000,000 during the PPP. (Obviously the $8,000,000 loan wasn’t auto decisioned — but it was still a digital experience from application to the borrower’s digital signature.

While that might seem unthinkable to the bank, from the borrowers’ perspective, it worked. They applied for and received multi-million dollar loans online. Why go back to paper?

As one executive put it, “digital is a delivery method we all need.” So one thing’s for sure: Commercial lending is about to change significantly for community banks. Digital will enable a transformation of business lending and a diversification of the bank’s loan portfolio — and the need for digital lending platforms is a top priority for the presidents and lending executives at community banks across the country.

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