The Green Sheet Online Edition
July 11, 2016 • Issue 16:07:01
FICO pedestal cracking
A FICO (Fair Isaac Corp.) score is an age-old criterion used by lending institutions in evaluating whether a person or business is creditworthy. Reliance on FICO scores is a widely accepted way to assess the level of risk a potential borrower presents. FICO scores are easy to obtain, have proven to be reliable and have become integral to the loan application process at financial institutions.
However, the FICO method of qualification may have seen its best days. Some industry experts even believe it could be on the road to extinction. Why? Lenders are finding that FICO scores aren't necessarily an accurate way to assess the financial strength of younger generations of consumers. This is because they tend to manage finances much differently than prior generations. Thus, a number of lending institutions have already begun considering alternative methods for qualifying younger loan applicants.
For example, a few progressive New Jersey mortgage bankers are formulating a new approach to qualifying millennial applicants. In a March 29, 2016, blog post, Residential Home Funding Corp. stated, "They'll take things like your savings, cash flow, future earning potential, and ability to pay monthly utilities into consideration, as opposed to just your credit score."
The ripple effect
Marketplace shifts such as this are breaking through longstanding lending traditions in other markets, as well. And, as these new practices begin to show promise, other financial services networks are finding new opportunities.
One area where great strides are being made is in small business lending. Much like the New Jersey mortgagers, alternative lenders are helping a business sector the banks and other traditional lenders couldn't touch.
By default, the FICO-based system excluded most new or small business entities from qualifying for traditional business loans. However, thanks to the emergence of small business lenders such as CAN Capital Inc., OnDeck and Kabbage Inc., the small business lending market is not only booming, it's changing America's economic landscape.
"America's 28 million small businesses are the engine of job creation and economic growth in this country, creating nearly two out of every three new jobs in the United States and employing over half the nation's workforce," James Hobson, OnDeck Chief Operating Officer said in a recent statement.
Parallel business model
With small businesses often serving as the bread and butter for ISOs, carving a niche in the small business lending market is a logical step. Furthermore, payments companies have access to a built-in transaction base for collateral. This idea was the impetus behind the emergence of the merchant cash advance model.
Many payment companies are dipping a toe in the water by incorporating third-party cash advance products into their portfolios, treating them like other value-added products. Others that have monitored the success of the small business loan market have been compelled to take a more direct approach.
Certain ISOs are putting greater emphasis on small business cash advance programs. For example, North American Bancard's wholly owned subsidiary Capital for Merchants offers small business merchants alternative financing to help promote growth without extra strings, hoops or mark-ups.
"We're changing perceptions about cash advance products in the industry through accelerated approvals and positive underwriting changes," Capital for Merchants President Rhett Rowe told The Green Sheet. "We can even board customers into the program that aren't existing NAB clients."
Meanwhile, aiming to ensure integrity, the Consumer Finance Protection Bureau is looking at the small business lending and cash advance sector. However, the government is unlikely to dampen this sector's prospects. OnDeck, for example, appears to be onto something necessary and big: it has more than 20,000 loans under its belt this year alone.
Furthermore, if a small company's transactions and other measures of viability can now supersede its FICO score and gain it critical seed cash, it's no wonder small business lending has exploded with the kind of promise traditional lenders could never have produced.
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