The FICO consumer credit score was first introduced in 1989 and is used today by 90% of all consumer lenders when determining loans and interest rates. And although the leading business credit score –FICO’s Small Business Scoring Service or SBSS Score – isn’t new, thanks to an SBA rule change, 2014 is posed to be the year of the small business credit score. This change has powerful implications for lenders and borrowers alike.
Commencing January 1st of this year all 7(a) loans up to and including $350,000 must begin with a pre-screening for an acceptable credit score as clarified in the SBA’s SOP 50 10 5 (F). A BoeFly.com analysis of SBA data from the previous fiscal year confirmed that this new rule affects a wide swath of loans – 33,000 SBA loans approved under $350,000 totaling $3.5 billion. The SBSS score is based on a combination of consumer, business and borrower data. The SBSS score, like its consumer cousin, predicts the risk of a loan in a three-digit score. According to FICO’s website its SBSS models are validated for “term loan, line of credit transactions, and commercial card obligations up to $1 million”.
Key points from the SOP:
• The minimum score is currently 140, but may be adjusted from time to time by SBA.
• The minimum score is set by SBA based upon the lower end of the risk profile of the SBA portfolio.
• If the score is below the minimum the loan may only be submitted as a standard 7(a) application to the LGPC or as an SBA Express Loan via E-Tran for a 50% guaranty if the lender is an Express Lender.
The exact reasons SBA established this new policy isn’t included in the SOP. But in the spirit of New Year’s prognostications, we offer a few thoughts as to why the SBA has acted:
• Scores reduce bias by relying on empirically derived algorithms. Regulators have a long history of seeking solutions that quiet an underwriter’s bias.
• Scores can reduce the cost of underwriting. The SBA has faced an uphill climb in getting lenders to fund small loan requests, which has been exasperated by the permanent change to $5 million 7(a) loans. With scores, lenders can reduce the cost without sacrificing diligence.
• The SBSS score works. Let’s face it; the SBA is in the business of reducing the approval of bad loans. By using a score that is proven to work, they are helping avoid unnecessary losses.
Smart lenders are already strategizing on how to profit from this rule change. One likely path is to pre-qualify applicants using the FICO SBSS score before ever doing the heavy lifting needed to secure the score from E-Tran. Even lenders skeptical about the role of business credit scores will likely agree that with this new rule change, business credit scores are here to stay.