Profit Minded

Which businesses default on loans most? Surprising data

When it comes to borrowing money, Vidur Dhanda says small businesses are not as risky as the banks think they are, and he has two terabytes of data to prove it.

A data-modeling expert and long-time financial industry consultant, Dhanda began three years ago aggregating data points on nearly all U.S. businesses. He licensed several proprietary databases, tapped the U.S. Census and Bureau of Labor Statistics, and wrote algorithms to chart businesses' defaults on a wide range of debts such as credit cards, vehicle and equipment leases, loans, and lines of credit.

Today, his company WAIN Street, named for its mission to bring Wall Street-style analysis to Main Street, publishes a monthly index that reports how well 18 million businesses in a variety of sectors and geographic regions are meeting their financial obligations. The WAIN Street Business Default Index is a unique barometer of the U.S. economy. And Dhanda says the data show that small businesses are far more reliable than big ones when it comes to paying down debt. Sole proprietors—a group he calls “solos” that accounts for $1 trillion in revenues—have the lowest default rates of all, he says.

WAIN Street’s data fly in the face of conventional lending wisdom. Banks usually consider small businesses bigger credit risks, and charge them higher interest rates than companies with more collateral. But Dhanda says those decisions are based on faulty assumptions. That’s because, despite frequent complaints—from the Small Business Administration and Senator Elizabeth Warren, among others—about the dearth of small business data, no one had been tracking such benchmarks before Dhanda.

Anecdotal evidence that solopreneurs are safe bets is abundant. Consider the success of microfinancing efforts in the developing world. The Grameen Bank in Bangladesh, which requires no collateral or even contracts on the loans it makes to impoverished women entrepreneurs, boasts a loan recovery rate of 97 percent. Closer to home, Dhanda points to Brooklyn, NY: “Loaning someone $1,000 to run their own food cart or coffee trolley can get better repayment because ‘my word is my bond’ there,” he says. Borrowers are too community-minded to make strategic defaults, he says: “They know if they pay back the lender, then the lady down the street can get the next loan.” But that’s not persuasive enough for lenders.

There is one caveat of Dhanda’s research: It’s possible that default rates are lower among small businesses because banks cherry pick the safest bets (while still charging them higher premiums). If this is true, he says, lenders are missing out on greater returns by not exposing themselves to enough risk.

He hopes his indexing products, which he offers as services to banks, will fix that. “We offer the ability for a bank to compare their performance to our index and make simple assertions such as, ‘our portfolio was better than the national or northeastern default rate, so the quality of our exposures is better.’”

Dhanda acknowledges that banks are in a difficult position when it comes to analyzing which among thousands of small businesses to back. “You can’t expend $5,000 worth of effort deciding to make a $5,000 loan,” he says. The WAIN Street index, however, can help loan officers see which industries are most secure, price loans better, and reduce interest rates for safer industries.

“None of these things are like revealed truths,” he says. “They’re data points. It’s much like human health: you can drink a bottle of wine every day and smoke cigarettes and still be in perfectly good health. I would never suggest a bank make a loan looking only at the index.”

But Dhanda is confident that the index makes one thing clear: “This cohort of businesses is not as risky as we consider them—either because we are leaving out too many of them, or because they are just less risky."

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