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:
Overall, bankers’ triage efforts should result in each relationship falling into one of four categories:
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:
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.
While harsh, the reality is that not much can be done here. Refer to Special Assets and move on.
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.
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.
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.
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:
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.
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?
Joel,
Great analysis and suggestions. I can’t believe how many businesses appear to be hanging their hopes on the SBA Disaster Relief loans. The servers can’t even handle the volume. I have no idea how SBA plans to manually process the millions of requests and the data they are requesting makes it look like the decisions will have to be based on traditional analysis? And these are all going SBA direct. At least last time around the 7(a) loan, with the 90% guaranty, spread the work out to the banks.
One additional thought is timeliness of the relief. Small business needs cash now. In Segment 3 or 4, and Segment 2 with low Risk of Loss Given Default be prepared with pre-approved solutions that can be quickly processed and implemented. CRE secured at acceptable LTV going in- just approve a 3 month payment holiday with principal and hopefully (if your regulator gets real) accrued interest added on to the back end. Make reamortizations easy. Waive fees and late fees – this is no time to maximize fee income. Hopefully regulators aren’t going to slam banks and label everything a TDR, when you do the right thing. I’m still on the side of do the right thing and accept the consequences.
Unless their are some creative, pre-approved programs, case-by-case will never be able to keep up with demand. Don’t demand YTD financials and throw your borrowers into a process. This is the time to prove those speeches about how you are a “Relationship Bank” weren’t a bunch of hot air. Banking can be a hero to our business partners.
Great article, Joel. Thanks for covering the small business customer segment in banking. Please keep beating the drum on how under-served these customers truly are today by most banks. This crisis has put a spotlight on how important it is for this industry to make drastic improvements. Part of our vision here at Autobooks is to help the banks better understand the financials of a SMB in an effort to get proactive vs. reactive. I’d love to share some of our SMB stories that are being shared right now from our progressive banking partners that have been early adopters in this industry. Cheers!