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  1. 1. Wells Fargo Business Direct Presentation to World Bank Finance Forum September 23, 2004 Strategies and Technologies for Improving Access to Finance: A Bank’s Perspective
  2. 2. Key Facts about Small Business Market Data Source: Dun & Bradstreet Business Databases. In U.S., there are a great many small businesses that are truly very small businesses, and most of these businesses are long established. Small businesses represent over 40% of the U.S. GDP, employ more than half of the country’s private workforce, and create three of every four new jobs. Distribution by Annual Sales Distribution by Time in Business
  3. 3. Small Business Lending Market Data Source: CRA, McKinsey Payments Practice, Tower Group. Lending small loans to small businesses is a big and growing business in the U.S. 16% CAGR 23% CAGR
  4. 4. History of Small Business Lending at Wells Fargo <ul><li>Prior to 1990, Wells Fargo was not a significant small business lender. </li></ul><ul><li>Late 1989, Business Banking Group formed in Retail Bank to focus on small business customers. Business Lending Division created to lend to firms with less than $10 Million in sales. </li></ul><ul><li>In 1994, cost studies showed that standard lending processes (distribution, underwriting, servicing) were uneconomic for smallest loans. </li></ul><ul><li>Business Direct formed in 1994 to focus on streamlined lending of up to $100,000 primarily to firms with less than $2 Million in sales. </li></ul>
  5. 5. Strategic Focus on Small Businesses – Challenging the Conventional Thinking Work began by segmenting small businesses into different segments and analyzing their profitability under standard processes. Cottage Businesses Family Providers Non-Profits Baby Bulls Merry Middles Profitable Unprofitable
  6. 6. Tax Returns, Financial Statements Required Application Reviewed in Detail by Lender Annual Review Required Collateral often Required Booked on Commercial Loan System Focus on Very Low Losses No Tax Return or Financials Needed Most Decisions Made Automatically Based on Scorecard No Review – Line is “Evergreen” Unsecured Booked on Consumer Loan System Higher Losses Acceptable with Risk-Based Pricing Applications by Mail, Phone, or Branch New Process Application in Branch or with Loan Officer Traditional Process Dramatic Changes Made to Make Small Business Lending Highly Profitable
  7. 7. Underwriting & Credit Scoring Marketing & New Product Development Account & Portfolio Management <ul><li>Attract low risk small business borrowers </li></ul><ul><ul><li>Data-driven targeted marketing </li></ul></ul><ul><ul><li>Attractive offers </li></ul></ul><ul><ul><li>Constant testing </li></ul></ul><ul><li>Develop new and innovative products and services </li></ul><ul><ul><li>Think out of the box </li></ul></ul><ul><ul><li>Cross-sale </li></ul></ul><ul><ul><li>Achieve higher growth rate and maintain the leadership position </li></ul></ul><ul><li>Use consumer credit techniques and develop small business specific rules and models </li></ul><ul><ul><li>Leverage information between businesses and their owners </li></ul></ul><ul><ul><li>More complex data and segmentation </li></ul></ul><ul><li>Constantly analyze, evaluate, and modify existing u/w policies and models </li></ul><ul><li>Conduct on-going assessment of the risk of each account </li></ul><ul><ul><li>Take action if needed </li></ul></ul><ul><li>Analyze and monitor the performance by customer segments </li></ul><ul><li>Maximize the profitability at the total portfolio level </li></ul><ul><ul><li>Create a balanced portfolio with diversified risks </li></ul></ul>Building a Lending Operating Focused on Small Businesses
  8. 8. Adverse and Positive Selection Marketing & New Product Development <ul><li>Making good, solid borrowers want to apply and use credit is critically important to the credit quality and profitability of the portfolio. </li></ul><ul><li>Examples of Adverse Selection: </li></ul><ul><ul><li>Long and involved application </li></ul></ul><ul><ul><li>Uninteresting offer: very small credit limit, very high interest rates or fees </li></ul></ul><ul><ul><li>Internet </li></ul></ul><ul><li>Carefully designed processes, such as simple application, can achieve two important objectives at the same time – lower losses by reducing adverse selection and increase product attractiveness. </li></ul><ul><ul><li>For small businesses, owners are the primary financial decision-makers. Saving time and keeping it simple are very important to them. </li></ul></ul>
  9. 9. Marketing Test and Product Innovation <ul><li>Constant testing, measuring, and learning is key to effective small business marketing. </li></ul><ul><ul><li>List sources </li></ul></ul><ul><ul><li>Product offers </li></ul></ul><ul><ul><li>Direct mail creative </li></ul></ul><ul><ul><li>Telemarketing Scripts </li></ul></ul><ul><ul><li>Channels – Branch, direct mail, telemarketing, internet, partnership </li></ul></ul><ul><ul><li>Disciplined analysis of test results required to succeed - What kind of customers are we attracting? what’s working? what’s not working? </li></ul></ul><ul><li>Continue to explore new ways to better serve small businesses. </li></ul><ul><ul><li>Ask why not - challenge current industry and our past conventional thinking. </li></ul></ul><ul><ul><li>Small experiments accelerate learning and obtain quick customer feedback. </li></ul></ul><ul><ul><li>Nurture entrepreneurial talent and encourage initiative ownership – established a separate group five years ago to manage new initiatives. </li></ul></ul>Marketing & New Product Development
  10. 10. The Business Direct Loan Decisioning Process Underwriting & Credit Scoring Targeting We target offers to long-established small businesses with good trade credit Business Loan Applications Data Input Integrity Controls Input errors can cause decision errors Verification and Pre-Screening Finds inconsistent/possibly fraudulent applications pre-scorecard declines Statistical Scorecard One or more statistical models for ranking applicant risk Out-sorted for Lender Review Rules determine which applications require a lender review Setting Price and Credit Amount Price and amount of credit granted set according to relative risk <ul><li>Over 1.5 Million applications processed. </li></ul><ul><li>2/3 rd of decisions made automatically with the remaining 1/3 rd reviewed by lenders. </li></ul><ul><li>Studies show our cost of processing small business loans among the lowest in the industry. </li></ul>Key Facts
  11. 11. How to Build a Successful Small Business Credit Scoring System Underwriting & Credit Scoring <ul><li>Collect Data </li></ul><ul><li>Collect data in a planned & organized manner. </li></ul><ul><li>Test different data sources: the more, the better. </li></ul><ul><li>Emphasis on data integrity. </li></ul><ul><li>Develop Models </li></ul><ul><li>Hire a skilled and dedicated internal team. </li></ul><ul><li>Develop models based on a large sample of small and well-diversified loans (industries & geographies). </li></ul><ul><li>Implement Strategy </li></ul><ul><li>Determine score boundaries to achieve desired outcome. </li></ul><ul><li>Overlay judgmental rules to control intuitive risks not adequately captured in scores. </li></ul><ul><li>Develop benchmark portfolios and set up tracking for future analysis. </li></ul><ul><li>Analyze, Evaluate and Modify the System </li></ul><ul><li>Segment-level analysis on total profitability. </li></ul><ul><li>Monitor early performance indicators and act quickly if needed. </li></ul><ul><li>Rebuild models periodically based on updated information. </li></ul><ul><li>Potential Data Elements for a Small Business Origination Scorecard </li></ul><ul><li>Industry </li></ul><ul><li>Years in business </li></ul><ul><li>Years as a bank customer </li></ul><ul><li>Credit history of the business owner(s) </li></ul><ul><li>Average deposit balance </li></ul><ul><li>Location of the business </li></ul><ul><li>Financial assets and liabilities of the owner(s) </li></ul>
  12. 12. An Illustrative Example of Scorecard Application Underwriting & Credit Scoring In addition to origination scorecards, Business Direct also use statistical models in marketing, customer management, collection, etc. <ul><li>Lower losses and/or higher approval rate </li></ul><ul><li>More efficient process and lower operational cost </li></ul><ul><li>Better customer service </li></ul><ul><li>Improving small business access to finance </li></ul>Key Benefits
  13. 13. After Booking – Account Management Conducting on-going assessment of the risk of each account and taking necessary actions to improve profitability. Account & Portfolio Management <ul><li>“ Behavior Scores” </li></ul><ul><ul><li>Statistical models for evaluating the risk of an existing borrower based on behavior. </li></ul></ul><ul><ul><li>Delinquency, usage, over-limit experience. </li></ul></ul><ul><li>Consumer Bureau Information </li></ul><ul><ul><li>Business Direct gets approximately 100 pieces of information from the consumer credit bureaus every month on every customer (score, utilization, inquiries, # accounts, open commitment, etc.). </li></ul></ul><ul><li>Small Business Loan Data </li></ul><ul><ul><li>Small Business Financial Exchange, D&B. </li></ul></ul><ul><li>Deposit Account Data </li></ul><ul><li>Pricing Changes </li></ul><ul><ul><li>Business Direct frequently increases customer pricing for risky behavior (frequent delinquency, over-limit). </li></ul></ul><ul><ul><li>Well performing, low risk customers get rate decreases. </li></ul></ul><ul><li>Line Increases for Good Customers </li></ul><ul><ul><li>Automatic or conditional line increases </li></ul></ul><ul><ul><li>Helps build low-risk balances, relative to balances of higher risk customers. </li></ul></ul><ul><li>Account Closures </li></ul><ul><li>Pre-Approved Cross-Sell </li></ul>
  14. 14. Proactive Portfolio Management Actions Boost Total Portfolio Profitability As in consumer lending, segment performance reporting and analysis should be extensive. Problems must be detected early and opportunities will also be found in the data. Account & Portfolio Management <ul><li>Industry </li></ul><ul><li>Geography </li></ul><ul><li>Origination Channel and Partner </li></ul><ul><li>Origination Risk Segment </li></ul><ul><li>List Sources and Offer </li></ul><ul><li>Business Type </li></ul><ul><li>Time in Business (young businesses) </li></ul><ul><li>Time Loan Originated </li></ul><ul><li>Loan Size, Rate and Usage Behavior </li></ul>Patterns should be analyzed by…
  15. 15. Business Direct Today – An Attractive Lending Business That Helps Small Businesses Succeed Underwriting & Credit Scoring Marketing & New Product Development Account & Portfolio Management <ul><li>410,000 customers in 50 states and Canada </li></ul><ul><li>Median sales: $ 325,000 </li></ul><ul><li>70% have 5 or fewer employees </li></ul><ul><li>Average line/loan balance: $ 15,000 </li></ul><ul><li>Median business deposits: $ 7,000 </li></ul><ul><li>Average time in business: 13 years </li></ul><ul><li>Average time as Business Direct customer: 5.5 years </li></ul><ul><li>$ 15 Billion in loan commitments </li></ul><ul><li>$ 6.3 Billion in loan outstandings - 94% unsecured </li></ul>
  16. 16. Creating a Winning Small Business Lending Organization and a Culture for Success <ul><li>Organizational and strategic focus on small business lending – a separate line organization supported by top management. </li></ul><ul><li>Create a conservative risk culture and at the same time encourage prudent risk-taking. </li></ul><ul><ul><li>Disciplined monitoring and analysis to catch poor performing groups early. </li></ul></ul><ul><li>Focus on building and improving key capabilities: </li></ul><ul><ul><li>Data, more data, and data analysis. </li></ul></ul><ul><ul><li>Emphasis on excellent execution. </li></ul></ul><ul><ul><li>Innovation is valued and rewarded. </li></ul></ul><ul><li>Attract and reward top talent. It can really make a difference! </li></ul>
  17. 17. Can the Lessons Be Applied Somewhere Else? RESOUCE <ul><li>Capital investment (Smart capital) </li></ul><ul><li>Organizational alignment and support </li></ul>A SUCCESSFUL SMALL BUSINESS LENDING BUSINESS INFRASTRUCTURE <ul><li>Stable & balanced legal and political environment (e.g., property right, contract/collection laws, etc. ) </li></ul><ul><li>Healthy and active small business segment </li></ul><ul><li>Sound payment & banking system (e.g. , interest rate flexibility for risk-based pricing) </li></ul><ul><li>Reliable communication and postal systems </li></ul>INFORMATION <ul><li>Good consumer bureaus (positive & negative) </li></ul><ul><li>Available business information sources </li></ul><ul><li>Robust customer information system </li></ul>PEOPLE <ul><li>A skilled, talented and committed internal team. </li></ul><ul><li>A culture of learning, innovation and calculated risk-taking. </li></ul>
  18. 18. Thank You Questions?