May/June 2014 – Issue 3

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Automated Intelligence

By: Michael Giusti

Underwriters are increasingly looking to computerized automation to streamline the funding process, but where does that leave the human touch?

Breslow, Arora, Petralia

In a dream world, the underwriting portion of a business funding deal would be as easy as a mouse click and as risk free as a bank deposit.

And while the risk-free, pain-free transaction may never be possible, computers, data and automation are taking an increasingly large role in the underwriting process. For underwriters, tapping into daily payment transactions is a must, but it is just the beginning of what is possible. The most innovative players in the alternative business lending industry are tapping into data sources never before dreamed of, ranging from UPS shipping volume to social media chatter, all to decide who should get funded and who is just too big of a risk.

It would seem that for most deals, the days are numbered for on-site risk assessment and underwriting that requires even nominal amounts of manpower. But how far can automation really go?

Over the past month, the DailyFunder picked the brains of three leaders in the business funding space to discover how computerized underwriting is going to fit into this evolving industry.

Noah Breslow, CEO of New York-based OnDeck Capital; Kathryn Petralia, co-founder and COO of Atlanta-based Kabbage; and Rohit Arora, CEO and co-founder of New York-based Biz2Credit Inc., offered a range of insights.

“OnDeck uses technology to evaluate business fundamentals – namely credit, and cash flow more efficiently. Those data sources are the most interesting to us,” Breslow said in a sentiment that echoes the tone of each of the executives.

The common themes were clear: automation is necessary, it is growing, and it is the key to staying competitive in an increasingly crowded marketplace.

“Automated underwriting makes us a lot more efficient and effective in serving small businesses because we can serve more of them more quickly and take less time out of their day to go through the application process, and get them to a ‘yes’ more quickly,” Petralia said. “And you can serve smaller merchants because it doesn’t cost as much to underwrite them.”

To be sure, personal attention is still coveted. But the big question is: can the business funding industry ever be free of that human touch?

Here they are, in their own words:

DailyFunder: How much of a role should computers play in underwriting a deal?

Breslow (OnDeck): While we are a tech-powered Main Street lender, we believe there is a perfect balance between technology and human touch when underwriting a loan. Our technology has enabled us to be more predictive when determining the creditworthiness of a small business, and our human touch allows us to work closely with our customers and better understand their individual capital needs.

Petralia (Kabbage): Huge. Keep in mind, we have it segregated in a couple different ways. We have this automated underwriting process. We have a credit-and-risk-management team that builds the models and understands the data. Then we separately have a data science team. We are collecting tons of data. We don’t use all the data. We identify all the data available, then comb through this data to find meaningful, relevant data points and we decide whether to include it in the model.

Arora (Biz2Credit): We like to include a lot of third-party data sources in the underwriting process. Our experience has been that in the underwriting process, there is a lot of clerical work, which is just getting all the data, looking at it, doing manual calculations. That part can be automated. Computers can do a very good job at that. Anything with traditional data, calculating ratios, those can be and have been fairly easily automated. Quantitatively we have found if humans do these types of things, we commit more mistakes than computers and there is less uniformity and more bias.

DailyFunder: Then, would it ever make sense to remove the human underwriter completely?

Breslow (OnDeck): We believe the right balance is critical.

Arora (Biz2Credit): I think we are not here because of two reasons. Algorithms are very sophisticated on the quantitative side, but when it comes to qualitative side, things like language recognition are not so advanced, and I think things to measure behavior are not yet there. Until then, you cannot eliminate the human element from an underwriting aspect, especially in the credit marketplace. Human beings are still playing a role. The human role is graduating more away from grunt and clerical to a more intelligent aspect. And that is good. But, I feel that a good mix is important and will continue to be important until technological limits are taken care of.

Petralia (Kabbage): It seems like this would be hard to do. It is not going to be like the “Matrix” where machines are making all the decisions. You won’t see an underwriting world without humans. There are humans involved in the conversation about which data source is interesting or meaningful or relevant, and whether we should plug it into the model. I don’t think that machine learning algorithms can rapidly deploy new models into production. I don’t think that makes sense. A human has to be involved in the strategy. If you have a machine and you get the data and you have built the model, then at that point there is no need to involve a human in it. But you have to have reporting that you look at on a daily basis to analyze and understand how the model is working, and that is a human who is looking at it from a day-to-day portfolio management standpoint. Certainly you want to have humans involved in that.

DailyFunder: So, with automation and data playing such a large role, are the merchants able to keep pace with the technological focus?

Breslow (OnDeck): The large majority of small businesses today are interacting and generating all sorts of electronic data. Most use smart phones, online banking, Quick Books, credit card processing, social data, etc.

Petralia (Kabbage): It is becoming more and more rare to find merchants who are not tech savvy. Think about it. Even if they still use an old-fashioned paper ledger, every small business in America has a checking account. There is automated access to those checking accounts. If they don’t have a checking account, nobody wants to work with them. But, there are also platforms being launched giving these guys access to better tools from an accounting perspective. It may be that QuickBooks is too complicated, so they use Xero or FreshBooks. But there are other tools that are drawing other customers in that are customized for them, even if it is just an invoicing program. And every one of those tools creates a tsunami of data that can be used in underwriting.

Arora (Biz2Credit): I am finding that if you have a responsive platform, and if technology is deployed the right way, it lets less technically savvy people get access to credit in a more democratic fashion. For example, if you have a mobile platform, you can input your information through your mobile, even if you don’t have a laptop or PC. We have found that that has enabled minorities and merchants that are not tech savvy or language savvy to participate much better.

DailyFunder: Would it be wrong to judge a business’ ability to repay based on their level of technical savvy?

Breslow (OnDeck): They are not judged by their tech and social media savvy — that is irrelevant. The fact is most businesses operating today, in 2014, are already technology focused to one degree or another. They have computers, they have online banking, they use credit card processors, their customers are reviewing them online, there are public records, etc. All this electronic data helps paint a deeper and more accurate picture of the health of a business.

Arora (Biz2Credit): Actually, what you have is various level of technical expertise. That is challenging but also an opportunity. We get people who come online. We give them live chat support and toll free numbers. We get them with a specialist with all the technology and all the tools and now they have access to funding that they might not have had otherwise. You can take it as a challenge but also opportunity. If they are less technologically savvy, they may need some handholding. But, if you provide that — and we do — you see good conversions and good loyalty. Once you overcome hurdles with these customers, they become some of your most loyal and most responsive customers.

DailyFunder: So how does social media play into all of this?

Petralia (Kabbage): When we added social media, we didn’t know what we were going to find. We were kind of curious. We found that the customers that added active Facebook and Twitter pages were 20 percent less likely to be delinquent, and it’s not because they could use technology. It’s because they were engaged with their customers. How do they interact with their customers? If you can get that information about how they interact, you can measure customer engagement. And that is a huge indication of business performance.

Breslow (OnDeck): Most of our customers use social media because it can be a valuable tool for growing their customer base. Having a web presence is crucial for small businesses such as restaurants, florists, auto body shops and other service-based businesses. If a business has a strong website, I don’t think they need to be on every social media channel. However, we have found that it is important to be on social media channels read by their target audience. Facebook and Yelp are the two we see used by most of our customers. For some industries, such as doctors and dentists, having a social presence isn’t as important and relevant as say a restaurant. We don’t think that merchants should be judged for loans by how social media savvy they are — that can lead to false positives — the worst business could have a great website and Twitter account but no cash flow.

DailyFunder: A lot of companies tout their personal relationships with the companies they fund. Is that still important, or is technology replacing some of that?

Breslow (OnDeck): Customer service is something we pride ourselves on and take very seriously. We make it a priority to intimately understand our customers’ businesses and needs. That way we can more effectively support them, provide the critical access to capital they need and help them grow. Excellent customer service is extremely important to us and it is a key part of our brand DNA.

Petralia (Kabbage): Most of the time they don’t want a personal relationship. They want to run their business. They want to engage WHEN they want to engage. We are effectively lending these guys money. And they are paying us fees. Most people wouldn’t be excited about that kind of a relationship. But when they call, we answer the phone. If they email, we respond to them. We have live chat. We are extremely engaging with our customers when THEY want us to engage.

Arora (Biz2Credit): I would say a combination works best. Automation helps you reduce costs in underwriting. It also reduces mistakes and reduces time. It also reduces bias against business owners who might struggle with an accent or with using proper language. We introduced a full technology platform a few years back, and we found a lot of customers in the middle of the night are using it on their own. People will use technology on their own and then call us if they run into issues. So, a smart combination of relationships and technology is the best right now.

DailyFunder: So, what I am hearing is that automation is the future, but there is still a role to be played by humans.

Arora (Biz2Credit): Underwriters still have a role to play in the areas that require judgment. For example, taking a look at and talking to other stakeholders, like landlords, even looking at different business in the same industry or geography. That is difficult to automate. That is less about data and more about intelligence. But the behavioral aspect, and other things like how the business owner describes their business, their vision, their growth plan, that cannot be automated. So, the key thing is it is a combination of quantitative and qualitative aspects of underwriting.

Breslow (OnDeck): You might use technology more on underwriting smaller or less risky loans, and people more for doing extra work and diligence on larger loans, or more risky loans. Not all loans are created equal, not all businesses have the same digital footprint, and that influences when human underwriters add value and should be used.

DailyFunder: So, what is the future going to hold?

Petralia (Kabbage): Some folks claim they are really automated and they are not. And you can tell by the number of employees they are hiring and where they are hiring how automated they really are. If you have a good system, and you know what data you are looking for, it’s not like you should need to add a new person for every 1,000 customers you add to your portfolio. With the technology, it is scalable. But there are a lot of funders out there who are still using manual processes. They have people who go knock on doors to determine creditworthiness and walk on the floor and evaluate, and then that person comes back and reports about that business. 1947 called. They want their underwriting back. It is crazy to me.

DailyFunder: Will those companies that do it by hand be able to survive in the marketplace?

Petralia (Kabbage): The reason they are able to do it the old way is that they make so much money on these deals, and there is no access to traditional bank lending for these merchants. There is such a need with small business owners that you can make a bunch of money, even doing it manually. They are still making money, but they risk fierce competition as more and more companies begin to automate the process. There is price competition. What you are going to see is price compression in the marketplace, and some of the less efficient companies won’t be able to compete or stick around.

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