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Wells Fargo Business DirectWells Fargo Business DirectPresentation to World Bank Finance Forum Presentation to World Bank Finance Forum September 23, 2004September 23, 2004

Wells Fargo Business DirectWells Fargo Business DirectPresentation to World Bank Finance Forum Presentation to World Bank Finance Forum September 23, 2004September 23, 2004

Strategies and Technologies for Strategies and Technologies for Improving Access to Finance: Improving Access to Finance:

A Bank’s PerspectiveA Bank’s Perspective

Strategies and Technologies for Strategies and Technologies for Improving Access to Finance: Improving Access to Finance:

A Bank’s PerspectiveA Bank’s Perspective

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Key Facts about Small Business MarketKey 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.

<$100K43%

$100-500K40%

$500K-$1MM7%

$1-5MM7%

$5MM +3%

Distribution by Annual Sales

0-3 Years7%

4-9 Years21%

10-19 Years43%

20+ Years29%

Distribution by Time in Business

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.

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Small Business Lending MarketSmall Business Lending Market

Data Source: CRA, McKinsey Payments Practice, Tower Group.

$0

$20

$40

$60

$80

$100

1998 1999 2000 2001 2002

Loans Under $ 100,000 Made to Businesses (Billions $)

16% CAGR

$0

$20

$40

$60

$80

$100

$120

1999 2000 2001 2002 2003Fcst

2004Fcst

Spending by Small Businesses on Business Cards (Billions $)

23% CAGR

Lending small loans to small businesses is a big and growing business in the U.S.

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History of Small Business Lending at Wells FargoHistory of Small Business Lending at Wells Fargo

• Prior to 1990, Wells Fargo was not a significant small business lender.

• 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.

• In 1994, cost studies showed that standard lending processes (distribution, underwriting, servicing) were uneconomic for smallest loans.

• 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.

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Strategic Focus on Small Businesses – Challenging the Conventional Thinking Strategic Focus on Small Businesses – Challenging the Conventional Thinking

Cash Cows Gazelles Professionals Entrepreneur Start-ups

Cottage Businesses

Family Providers

Non-Profits

Baby Bulls

Merry MiddlesProfitable

Unprofitable

Work began by segmenting small businesses into different segments and analyzing their profitability under standard processes.

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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 ProfitableDramatic Changes Made to Make Small Business Lending Highly Profitable

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Underwriting &

Credit ScoringMarketing & New

Product DevelopmentAccount & Portfolio

Management

• Attract low risk small business borrowers

– Data-driven targeted marketing

– Attractive offers– Constant testing

• Develop new and innovative products and services

– Think out of the box– Cross-sale– Achieve higher growth

rate and maintain the leadership position

• Use consumer credit techniques and develop small business specific rules and models

– Leverage information between businesses and their owners

– More complex data and segmentation

• Constantly analyze, evaluate, and modify existing u/w policies and models

• Conduct on-going assessment of the risk of each account

– Take action if needed• Analyze and monitor

the performance by customer segments

• Maximize the profitability at the total portfolio level

– Create a balanced portfolio with diversified risks

Building a Lending Operating Focused on Small BusinessesBuilding a Lending Operating Focused on Small Businesses

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Adverse and Positive SelectionAdverse and Positive Selection

Marketing & NewProduct Development

• Making good, solid borrowers want to apply and use credit is critically important to the credit quality and profitability of the portfolio.

• Examples of Adverse Selection:– Long and involved application– Uninteresting offer: very small credit limit, very high interest rates or fees– Internet

• 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.

– For small businesses, owners are the primary financial decision-makers. Saving time and keeping it simple are very important to them.

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Marketing Test and Product InnovationMarketing Test and Product Innovation

• Constant testing, measuring, and learning is key to effective small business marketing.

– List sources– Product offers– Direct mail creative– Telemarketing Scripts– Channels – Branch, direct mail, telemarketing, internet, partnership– Disciplined analysis of test results required to succeed - What kind of

customers are we attracting? what’s working? what’s not working?

• Continue to explore new ways to better serve small businesses.– Ask why not - challenge current industry and our past conventional thinking. – Small experiments accelerate learning and obtain quick customer feedback.– Nurture entrepreneurial talent and encourage initiative ownership –

established a separate group five years ago to manage new initiatives.

Marketing & NewProduct Development

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The Business Direct Loan Decisioning ProcessThe Business Direct Loan Decisioning Process

TargetingWe target offers to long-

established small businesses with good trade credit

Business Loan Applications

Data Input Integrity ControlsInput errors can cause decision errors

Verification and Pre-ScreeningFinds inconsistent/possibly fraudulent applications

pre-scorecard declines

Statistical ScorecardOne or more statistical models for ranking applicant risk

Out-sorted for Lender ReviewRules determine which applications require a lender review

Setting Price and Credit AmountPrice and amount of credit granted set according to relative risk

Underwriting &

Credit Scoring

• Over 1.5 Million applications processed.

• 2/3rd of decisions made automatically with the remaining 1/3rd reviewed by lenders.

• Studies show our cost of processing small business loans among the lowest in the industry.

Key Facts

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How to Build a Successful Small Business Credit Scoring SystemHow to Build a Successful Small Business Credit Scoring System

Underwriting &

Credit Scoring

Collect Data• Collect data in a planned &

organized manner.• Test different data sources:

the more, the better.• Emphasis on data integrity.

Develop Models• Hire a skilled and dedicated

internal team.• Develop models based on a

large sample of small and well-diversified loans (industries & geographies).

Implement Strategy• Determine score boundaries to

achieve desired outcome.• Overlay judgmental rules to

control intuitive risks not adequately captured in scores.

• Develop benchmark portfolios and set up tracking for future analysis.

Analyze, Evaluate and Modify the System

• Segment-level analysis on total profitability.

• Monitor early performance indicators and act quickly if needed.

• Rebuild models periodically based on updated information.

Potential Data Elements for a Small Business

Origination Scorecard• Industry• Years in business• Years as a bank customer• Credit history of the business

owner(s)• Average deposit balance• Location of the business• Financial assets and liabilities of

the owner(s)

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An Illustrative Example of Scorecard ApplicationAn Illustrative Example of Scorecard Application

Underwriting &

Credit Scoring

• Lower losses and/or higher approval rate

• More efficient process and lower operational cost

• Better customer service

• Improving small business access to finance

Key BenefitsRisk Score Performance Graph

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10

20

30

40

50

60

70

80

90

100

0 10 20 30 40 50 60 70 80 90 100

% of Customers

% o

f Bad

In addition to origination scorecards, Business Direct also use statistical models in marketing, customer management, collection, etc.

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After Booking – Account ManagementAfter Booking – Account Management

Conducting on-going assessment of the risk of each account and taking necessary actions to improve profitability.

• “Behavior Scores” – Statistical models for evaluating the risk

of an existing borrower based on behavior.

– Delinquency, usage, over-limit experience.

• Consumer Bureau Information– 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.).

• Small Business Loan Data– Small Business Financial Exchange,

D&B.

• Deposit Account Data

Account & PortfolioManagement

• Pricing Changes– Business Direct frequently increases

customer pricing for risky behavior (frequent delinquency, over-limit).

– Well performing, low risk customers get rate decreases.

• Line Increases for Good Customers– Automatic or conditional line increases– Helps build low-risk balances, relative to

balances of higher risk customers.

• Account Closures

• Pre-Approved Cross-Sell

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Proactive Portfolio Management Actions Boost Total Portfolio ProfitabilityProactive 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.

• Industry• Geography• Origination Channel and Partner• Origination Risk Segment• List Sources and Offer• Business Type• Time in Business (young businesses)• Time Loan Originated• Loan Size, Rate and Usage Behavior

Patterns should be analyzed by…

Account & PortfolioManagement

Loss Vintage Curves - Annualized Gross Loss Rate for Two Segments

0%

1%

2%

3%

4%

5%

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46

Months from Origination

Ann

ualiz

ed L

oss

Rat

eNew Segment

Segment X

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Business Direct Today – An Attractive Lending Business That Helps Small Businesses SucceedBusiness Direct Today – An Attractive Lending Business That Helps Small Businesses Succeed

Underwriting &

Credit ScoringMarketing & New

Product DevelopmentAccount & Portfolio

Management

Annual Profit

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004Fcst

• 410,000 customers in 50 states and Canada

• Median sales: $ 325,000

• 70% have 5 or fewer employees

• Average line/loan balance: $ 15,000

• Median business deposits: $ 7,000

• Average time in business: 13 years

• Average time as Business Direct customer: 5.5 years

• $ 15 Billion in loan commitments• $ 6.3 Billion in loan outstandings -

94% unsecured

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Creating a Winning Small Business Lending Organization and a Culture for SuccessCreating a Winning Small Business Lending Organization and a Culture for Success

• Organizational and strategic focus on small business lending – a separate line organization supported by top management.

• Create a conservative risk culture and at the same time encourage prudent risk-taking. – Disciplined monitoring and analysis to catch poor performing

groups early.

• Focus on building and improving key capabilities:– Data, more data, and data analysis.– Emphasis on excellent execution.– Innovation is valued and rewarded.

• Attract and reward top talent. It can really make a difference!

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RESOUCE

• Capital investment (Smart capital)

• Organizational alignment and support

Can the Lessons Be Applied Somewhere Else? Can the Lessons Be Applied Somewhere Else?

A SUCCESSFUL SMALL BUSINESS LENDING BUSINESS

INFRASTRUCTURE• Stable & balanced legal and political environment (e.g.,

property right, contract/collection laws, etc. )• Healthy and active small business segment

• Sound payment & banking system (e.g. , interest rate flexibility for risk-based pricing)

• Reliable communication and postal systems

INFORMATION

• Good consumer bureaus (positive & negative)

• Available business information sources

• Robust customer information system

PEOPLE

• A skilled, talented and committed internal team.

• A culture of learning, innovation and calculated risk-taking.

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Thank You

Questions?

Thank You

Questions?