An underutilized sign of risk: Business exits
Search the internet for business exit strategies, and you’ll see plenty of methods to wind down a company. If only the world were so orderly.
Businesses don’t always close their doors in a predictable manner with debts settled through a bankruptcy proceeding and the property liquidated. Most times, small businesses simply close their doors.
Business exits, as Powerlytics Business Exit data shows, are a prime predictor of loan defaults. For lenders, the rate at which businesses close their doors, and the characteristics of those businesses, can inform the pricing of risk and uncover risks that do not appear on the loan application.
Powerlytics recently conducted a detailed analysis of the factors that accurately predict credit risk for one of its lending clients leveraging two Powerlytics data sets. The first was the Business Financial data, which covers over 30 million for-profit businesses in the U.S. The second was the newly compiled Business Exit data and scores, which consists of annual data on business starts and closures across a full range of variables – legal form, industry, geography, employment class, and sales. The data was then merged with a customer data file that contained the histories of thousands of loans, including the year of origination, industry, zip code, and revenue class.
The analysis found a 98 percent correlation between loan defaults and the Powerlytics business exit score when the business had between $500,000 and $500 million in annual revenue.
Default rates tended to be much higher for businesses at the smaller end of the revenue spectrum, but factors such as location and industry sector in addition to size play an important role. In this case, those with between $500,000 and $1 million in annual sales defaulted 3.4 times more than those with between $250 million and $500 million in revenue.
The Exit and Entry Series is fine-tuned for accuracy. It only includes businesses that have actually closed, not those that have merged or been sold. For lenders, the ability to predict which types of businesses might shut their doors is a powerful one. The analysis considers the size, location, and industry sector of the company. The result is a more accurate picture of default risk.
While Powerlytics business exit and default scores can provide a much more accurate ability to predict small business default at loan origination, it can also be used to evaluate portfolio risk. As a result, utilizing these scores can better inform risk based interest rate decisions, credit approval decisions, and help to better manage overall portfolio risk.
With preapproved loan marketing campaigns, Powerlytics can assist with developing campaigns targeted to those companies that have a lower risk of default and a higher likelihood to take advantage of the offer.
Whether the focus in on risk based underwriting or marketing decisions, Powerlytics proprietary business exit and default models can dramatically improve results.