What I learned working in lending and why Fintechs like Codat are the solution
There is no doubt that alternative lenders provide a valuable service. Now more than ever, they are a god-send for the SMBs they serve as they democratize access to capital.
During my time working at one of the largest SMB lenders in the US, I encountered first-hand a number of difficulties at various stages of the lending lifecycle. In 2020, these issues were further exacerbated by the challenging and turbulent conditions caused by the pandemic.
This article outlines four key problem areas facing lenders today, and how each issue could be significantly improved with access to better real-time financial data.
One of the biggest challenges lenders and SMBs face is document collection. When time is money, SMB owners aren’t interested in downloading PDF files or asking their accountant to send them financial statements.
With the pandemic in full swing, lenders are becoming more risk averse and are requesting even more documentation than usual - and at a time where a small business may need access to a line of credit fast.
Reducing the friction in the document collection process is one of the most effective ways lenders can improve conversion rate, get applications completed and ultimately fund more deals.
Codat allows customers to sync their accounting package during the application stage, taking the heavy lifting out of document collection and facilitating faster onboarding and underwriting based on complete and up-to-date financials. Codat pulls this data as it appears in the accounting system and matches the different accounting software formats to one consistent standard, ensuring reliable data.
Lenders tend to view the relationship between the frequency of deposits into an account and concentration risk as inversely correlated. The assumption is that the more often a deposit is made, the lower risk that customer will be.
As a result, small businesses who should be creditworthy may get declined. For example, ecommerce retailers tend to get turned away when they apply for credit because large platforms such as Amazon will typically issue two large deposits into a seller’s account per month. This is viewed by some lenders as too much of a risk
In reality, greater context is required in order to understand where the deposits are coming from. Codat allows lenders to easily dig deeper to make smarter, more informed lending decisions.
Using Codat, the lender is able to drill down into each deposit from the bank statement to see where it matches up with the invoice on the income statement. For example, if there’s a question about the frequency of deposits, a deposit slip or invoice can be pulled to verify where the deposit came from and how many sales truly occurred. This could well reveal that one individual deposit actually accounts for a large number of separate sales.
One advantage of short term lending is that it only requires a few months of bank data to create a decision, but this lack of data can often limit the options available to a borrower.
Due to a mostly automated underwriting process that tends to focus on historical bank statements, the offers lenders provide are often inflexible meaning they may not meet the customer’s needs.
For example, a client looking for $250,000 to cover the up front material costs of their contracting company to fulfil a new project may not see the fruits of their labor for 6-9 months. An automated lending decision may produce an approval for a 6 month term with weekly payments of $11,000. For an experienced business owner, who knows projects get delayed and clients can be slow to pay, that weekly cash burn may not be feasible.
Lenders understandably don’t want to pay a Credit Analyst to spend time manually reviewing more paperwork. If the financial data required to assess the application could be gathered up-front by syncing the customer’s accounting software, then the lender would be able to use this data to inform the loan offers they present. Codat makes this level of connectivity possible by enabling real-time financial data to be pulled directly into a lender’s credit model.
“So once we do this deal, you’ll be able to increase my credit line, right?”
This question is one that most lenders are used to hearing. The pandemic has caused lenders to become more risk averse. As a result, many are either not increasing lines at all, shutting off LOCs all together or promising merchants that LOCs are reviewed periodically and are subject to increase automatically.
Unfortunately, just because a customer borrows frequently and has a track record of paying back on time, does not mean they should qualify for a larger line assignment.
The only way for a lender to effectively manage risk is to monitor data in real time and on an ongoing basis. One way lenders can do this is through an automated, ongoing credit assessment, via an API pulling data from a merchant's accounting software.
By partnering with Codat, lenders can streamline practically every stage of the lending lifecycle; from initial applications and document collection to repayments and renewals.
You can find more about how Codat is democratizing access to real-time financial data for lenders such as Cleabanc and MarketFinance here.