Small business loans under $100K must be digital in order to compete with online lenders

The recently-released 2017 U.S. Digital Lending Landscape white paper by S&P Global Market Intelligence projects that digital lenders, like OnDeck and Kabbage, will originate $62.84 billion in new loans in 2021 across the personal, small and medium enterprise, and student-focused segments. This prediction represents a compound annual growth rate of 16.5%, although SME-focused lenders are projected to grow the fastest over the next five years, with an estimated CAGR of 21.5% through 2021.

With 99.7% of all businesses in the U.S. classified as small businesses (according to the U.S. Small Business Administration), these projections should be encouraging to credit unions that are investigating the plausibility of offering digital loans to this market. The numbers indicate that there is no shortage of small businesses looking for funding.

The challenge, then, is not in finding an audience, but in offering a loan that is profitable for the credit union and also meets the needs of small businesses that are increasingly seeking alternatives to the 25 hours of research and paperwork it typically requires to obtain funding, according to a recent Baker Hill digital white paper. Indeed, the desire for speed and ease in the transaction is so strong that according to Baker Hill, almost half of small businesses who currently utilize digital capabilities will switch financial institutions altogether for an improved digital experience, even if it means paying significantly higher annualized interest rates.

Enter digital innovation.

Digital technology not only lowers the overall cost to originate, underwrite, fund and manage small business loans, it satisfies the business’s desire to obtain the loan almost immediately.

More than half of all small business loans are for $100K or less. However, community financial institutions—those with fewer than $10B in assets—hold only 9% of these loans, ceding them to alternative lenders, credit cards, etc.

The reason? Credit unions cannot make money today on small business loans under $100,000. According to Charles Wendel, president of Financial Institutions Consulting (FIC), net income for a typical $100,000 loan that requires the same amount of effort to originate, underwrite and manage as a loan for $1 million or more, ranges from -$600 to a mere $150.

Introducing digital technology to the loan process, however, can reduce the cost from about $2,500 to less than $250. With improvements like this, it is easy to see how digital technology can increase the number of small business loans and also their profitability.

But the financial benefits of digital technology extend far beyond your loan portfolio. According to the same Baker Hill white paper, institutions that adopt new digital technologies:

• Generate more revenue than those that do not. A study that tracked account holders who use digital capabilities over a two-year period showed that monthly revenue per account holder jumped by nearly 11-13% in those who engaged in the institution’s digital products.
• Double the average number of product holdings per account holder (includes primarily loans, certificates of deposit, mortgages and credit cards).
• Experience lowered attrition, with 35% of digital account holders more likely to remain with their institution than non-digital account holders.
• Enjoy greater cost and time savings—the cost of processing a transaction via mobile phone is as much as 50% lower than the cost via a branch.

Community and regional credit unions that want to seize upon the large, actively-borrowing small business market must embrace digital lending technology in order to compete with digital lenders.