Credit scoring moves into commercial lending field
By Pat Curry • Bankrate.com

Credit scores, those hush-hush secret numbers that bankers use to decide whether you deserve a mortgage, are now on the rise in business lending, too.

It's good for business owners, lenders say, because credit scoring speeds up the process and cuts paperwork, making more small loans available.

But no, even though a credit score can determine whether you'll open a business, you can't see yours.

As in consumer lending, standard procedure in small business credit scoring is that if you want your credit score, you're going to have to ask for it. Lenders aren't required to give it you and generally don't discuss it. They'll tell you what problems they found in your credit report, but not the score.

David Etter, executive vice president and chief credit officer of First International Bank in Hartford, Conn., says his loan officers don't discuss the credit score provided by Fair, Isaac and Co.

"Even internally, the derivation isn't well-understood," he says. "It's an easy, consistent way of pulling in business and consumer data and certain characteristics of that data and say, 'A large pool has performed this way.' But we don't reject loans purely because of a Fair, Isaac score. It just goes into a different category of underwriting."

"The lending institution doesn't gain anything in providing a score; it will be meaningless," said Anna Solberg, Fair, Isaac's commercial product line manager. "If a score was very high, but there was a bankruptcy, the decline letter would reference the bankruptcy."

Business scores arrived at differently
While the uses of credit scores are similar in consumer and business lending, the scores are determined in different fashions.

Business scoring models are dramatically different, as is the data that goes into establishing the number. While the vast majority of mortgages are rated on the Fair, Isaac model commonly known as a FICO score, commercial lending is much more customized, with many banks developing their own scoring models that can apply different weights to the same information, depending on the bank's lending practices. Other models cover the likelihood of business failure and the chance that your business is a scam; it all figures into the big picture.

Even the numbers on the scales aren't close to matching. On the consumer side, a score of 600 is considered very poor; in small business lending, a 300 would indicate a sterling credit history.

"We collect the sales size of the business, the industry type, the number of years in business, assets of the company, checking account balances, total cash on hand, net income and liabilities," said David Prus, vice president of small business services with Cleveland-based KeyBank. "A higher score would be in the 300-320 range. Lower scores area in the 100 range. The average score for good credit is 190."

Etter agreed.

"A 25-year mortgage is a 25-year mortgage," he said. "An equipment line is a different animal. Commercial lending -- there's still an art to it; it's not just science. No two businesses have the same business or legal structure. Commercial scoring in and of itself isn't a decision-making tool, but it's a real good screening tool."

Who's helped, who's hurt
But is it good for your company? Not if you're a newcomer.

"While business credit scoring may be somewhat beneficial for well-established businesses, it may not be so beneficial for others," said Christine Pacek, associate director of the University of Iowa's Small Business Development Center.

For example, Pacek notes that startup or high-growth businesses typically present more risk to a bank. They compare poorly to established businesses in collateral and repayment. "Unless the bank has different parameters for approving loans to these types of businesses," she said, "the loan request may very well get turned down."

 

How credit scoring works

Credit scoring uses a mathematical model to sift a loan applicant's credit history and compare it to thousands of previous loans. The result is a score that predicts the likelihood that the borrower will repay the loan. The higher the score, the better the risk looks to the lender. The scores can be quickly generated by computer, vastly speeding up loan processing. Most financial institutions use a cut-off score to rate their loans. If the score is above a certain point, it sails through; if it falls below the cut-off, it enters a segment of underwriting that involves a lot more paperwork, hands-on attention and documentation.

Prus disagreed, saying his bank "lends more to startups today than we ever have because of credit scoring," primarily based on the reliability of the consumer FICO score of the company's principals.

Pacek said credit scoring could also represent a problem in a long-term lending relationship.

"If a consistently profitable business has an unprofitable year, the business's credit score for that period would certainly raise a red flag in the eyes of bank management," she said. "If the business has a line of credit with the bank, and the bank is trying to lower its risk level in its overall portfolio, the bank may not renew the line of credit."

That's why many banks lean less heavily on credit scoring for business.

"There's no way you can rely on a score on a small business side," said David Graves, vice president of Decision Control Services at Digital Matrix Systems, a company that specializes in the processing of credit data and helps lenders establish their own risk guidelines. "For startups, there's not that much information. Take the Internet companies. If you looked at a Dun & Bradstreet report on these guys, there's no way would you give them money. But you know that the one in 50 you turn down will be sold for $4 billion. There's just no way to know."

Fair, Isaac has developed models that address just those kinds of issues and adjust for them.

"There are differences in how a small business owner acts," Solberg said. "We know they're entrepreneurs and entrepreneurs behave differently than general consumers. They tend to have a lot more credit and shop for credit more."

How to boost your score

The ways to boost your credit score on the small business side are similar to the recommendations given to consumers. In fact, since most small business loans are guaranteed by the principal, that person's personal credit history will be of paramount importance.

If you are a brand-new business or a home-based business, your company's credit information might not show up anywhere, Solberg noted. In those cases, credit scoring models default to the consumer credit bureaus.

  "If they haven't established a track record for the business, their personal record will come to bear," she said.

Experts recommend that you pull a copy of your credit report (you can get a self-inquiry for free from Dun & Bradstreet by calling 1-800-333-0505. Press 1 on the menu options.) several months before you plan to pursue financing, and make sure all the information is accurate and up to date. If there are delinquencies, judgments or liens, clear them up before you head to the bank.

"The absolutely worst thing you can do (to your credit score) is declare bankruptcy," Prus said, "then, unsatisfied liens like tax liens or any other collection issues. Those are major derogatories. If you were late on your mortgage by 15 days, that's a minor derogatory. If you were late one time in the last two years, and it's the only time you're late, it's not going to keep you from getting approved. If there's more than one bill you pay regularly on a late basis, that's certainly going to be an issue."

Another major issue, he said, will be how much credit card debt you have vs. how much you have available.

"It would certainly benefit you to pay off balances," he said.

Pat Curry is a freelance writer based in Georgia
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-- Posted: May 8, 2000