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A middle-market firm is one with a size that falls in the middle range of a market or industry. U.S. businesses can be divided into three categories – the big, middle-market, and small businesses. The middle-market firms are larger than the small businesses and smaller than the big businesses. They can be further divided into the upper-middle, middle, and lower-middle markets.
No unified standard exists to define middle-market firms. The size of a firm can be measured through various metrics, i.e., asset size, annual revenue, net income, or the number of employees. Compared with the Fortune 1000 companies, middle-market firms offer more growth potential. Compared with small businesses, they are lower in risk.
Different authorities use different definitions for middle-market firms. The standards may vary in different industries regarding the requirements for human and physical capitals or the existence of outliers.
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Typically, in the U.S., companies with annual revenues above $100 million and below $3 billion are regarded as middle-market firms. Defined by the number of employees, the companies with more than 100 and less than 2, 000 employees can usually be considered to be middle-market firms.
Several organizations exist to support the development of middle-market firms. The Association for Corporate Growth (ACG) is one example. The ACG aims at driving the growth of the middle market by supporting a global community for corporations and professional service firms.
Generally, larger companies come with a lower risk to invest in but are more limited in growth potential. Hence, mid-cap stocks enjoy a bigger space to grow than the large-caps and come with lower investment risk than the small-caps at the same time. Such a characteristic makes mid-cap stocks attractive to investors.
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Investors can track the performance of mid-cap stocks through several indices, such as the S&P Mid-Cap 400 Index, the CRSP U.S. Mid-Cap Index, and the Russell Mid-Cap Index. The S&P Mid-Cap 400 is a float-weighted index that covers 400 U.S. middle-market firms. It defines the mid-cap stocks as the ones with their market capitalizations above $200 million and below $5 billion. Firms that fall below the $200-million threshold are classified as small-cap, and those with more than $5 billion are classified as large-cap.
Investors can invest in middle-market firms by purchasing their shares directly or through ETFs. There are a wide variety of mid-cap ETF selections available. Examples include iShare S&P U.S. Mid-Cap Index ETF, Vanguard Mid-Cap Growth Fund (VOT), and Invesco S&P Mid-Cap Low Volatility ETF (XMLV).
VOT is a passively managed fund. It replicates the CRSP US Mid Cap Growth Index, which covers 158 U.S. mid-cap stocks with the growth style. XMLV tracks the S&P Mid-Cap 400 Low Volatility Index with more than 90% of its assets. The index contains 80 mid-cap stocks with the lowest 12-month realized volatility from the S&P Mid-Cap 400 Index.
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In the investment bank industry, the Bulge Bracket consists of the largest global investment banks of the world, i.e., J.P. Morgan, Goldman Sachs, and Barclays Capital. The Bulge Bracket banks usually offer mergers & acquisitions (M&A), initial public offering (IPO), and corporate financing advisory to large multi-national businesses.
The middle-market investment banks, which are smaller than the Bulge Bracket ones, usually provide services to mid-cap firms. Many middle-market investment banks are full-service banks that also offer commercial banking services but operate over a boutique platform in investment banking and capital markets.
Examples of middle-market investment banks include BMO Capital Market, RBC Capital Markets, and SunTrust. RBC Capital Markets and BMO Capital Markets are in the Bulge Bracket list in their domestic market – Canada – but are considered to take on a middle-market presence, comparing with the Wall Street players.
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In this article, we provide a summary of findings from our recent market research study on small business lending, which focused on the lending process and the challenges associated with banks’ credit risk assessments. This article provides an overview of small business lending today, discusses challenges and emerging trends, and provides recommendations for addressing the challenges to create a more streamlined and automated lending process.
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In a recent market research study focused on challenges of small business lending and credit risk assessment by banks, Moody’s Analytics concluded that emerging technology, innovative use of data, and expectations of an enhanced borrower experience will drive significant change in small business lending in the coming years.
The study was based on interviews with traditional lenders and emerging players in the financial technology (fintech) space on how they segment their business customers, the processes they use to evaluate credit worthiness of small businesses, and the challenges with these processes. Findings from the interviews were complemented by secondary industry research; insights from participation in banking, fintech, and small business events; and ongoing engagement with Moody’s Analytics customers.
For small business lending above the branch banking level, most bank lenders request three years of financial statements, collected either via unaudited financial reports from the prospective borrower or in the form of tax returns for the business. Financials may be complemented with bureau data on credit utilization and payment behavior.
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The collected data is typically applied in an internal scoring model with attributes assessing the creditworthiness of both the business and the proprietor or guarantors. This information is collected and entered manually into bank systems to produce an internal risk rating, which may be benchmarked against a number of external scores. Few banks have implemented auto-decisioning or indicated that they make small business loan decisions based primarily on a quantitative model. Figure 2 illustrates this process.
Although small business loans constitute more than a quarter of the lending volume in the US, most banks do not have effective systems and practices to accurately and efficiently assess small business risk and seamlessly conduct lending activities. The challenges generally fall into two categories: data problems and process problems. With respect to data, these challenges exist:
Even when lending decisions are made, a gap remains in terms of systems needed to document, monitor, and report on portfolio performance.
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Banks may encounter challenges through every step of the lending cycle, from information-gathering through monitoring and portfolio management. These challenges are summarized in Figure 3.
Small businesses are searching for easier access to loans in the face of shrinking funding and a lukewarm response from traditional banks, which are struggling to buoy margins in a low interest rate regime. Alternative lenders are emerging at a feverish pace to fi ll this funding gap, but they have the challenge of creating reliable credit assessment models and bracing themselves for increased regulatory scrutiny. Against this background, we identified four categories of trends that will drive significant change in small business lending in the coming years (Figure 4).
Lending organizations have opportunities to improve the small business lending process in all parts of the credit life cycle. Organizations currently have these main opportunities for improvement:
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Based on the findings of our research, including emerging trends and opportunities for improvement, the Moody’s Analytics view of the future state of lending focuses on these elements:
To meet the challenges of a rapidly changing market, banks will need to adopt tools and technologies for enhanced data collection, process automation, automated scoring, and rule-based decisioning. Transforming the small business lending process will also require banks and their partners to leverage new credit information solutions and rethink the way they collect and use customer and prospect data to create credible, quantitative, and demonstrably validated credit decisioning frameworks.
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Devoted to the convergence of risk, finance, and accounting disciplines with regard to the new impairment standard, Financial Instruments -- Credit Losses, commonly known as the current expected credit loss (CECL) approach.
Join Moody's Analytics and our panel of financial institution executives, as they share their challenges and successes in navigating the second round of the SBA's PPP Loan Program, as well as the potential for the third and fourth round of stimulus for small businesses.
Learn how leading organizations are leveraging technological advances and risk assessment to: streamline processes; build more efficient, consistent, and profitable small business