Exploring member business lending (MBLs) during 2019 was one recurring priority I heard during this year’s planning season. As management discussed that proposition, without fail, angst would follow as the lending institutions considered this type of significant initiative. Credit unions realize that commercial lending differs significantly from consumer lending, with some lessons still fresh from experiences throughout the Great Recession.
Despite those experiences, an acceptable contact with MBLs can serve members’ needs while providing positive yield. So, why must a bank offer business lending, what considerations must it take, and just how should it do it? It may achieve this by answering three a quick question.
The first question to inquire about is: “Why?”
Why is your bank considering MBLs? There are just three possible answers: to serve members’ needs, to create loan yield, or both.
While the email address details are simple, this decision point is critical. Your credit union’s “why” influences every other decision your bank can make. That answer impacts product sets, structure, risk, staffing, financial outcome, and marketing. The answer is so critical, it’s worth asking again to ensure that you develop the same answer. Could it be really about member service, or are we really just doing the work to maintain our competitors? Is MBL yield well worth the increased risk i will be taking?
It is critical that management and the Board are lockstep in your “why” for offering MBLs. Any difference in answers forwards and backwards bodies will result in confusion and dissension. If management wants to do MBLs and the Board does not, the Board will probably second-guess management for years to come. Conversely, when the Board likes MBLs and management is opposed, the initiative is likely doomed from the beginning. The groups must agree with if you should pursue MBLs, plus they must agree on the “why” for doing this or not doing this.
Having solved the first question, your next question is: “What?”
Just just like consumer lending, it can be a challenge to meet the loan Union philosophy with regards to commercial loans. The underserved member business borrowers could be short on capital and collateral. Absent adequate capital and collateral (amongst other things), the risk on any loan increases. Being new to MBLs, your bank might not have an appetite to serve that underserved market in a meaningful manner. In that way, MBLs to borrowers with big ideas and large dreams – but little capital and experience – represent financing your credit unions might be hesitant to make.
If, then, you are planning to turn to stronger loans with adequate capital and collateral, you will probably find an already-crowded field of monetary institutions competing for your same business. Competitors abound in most markets for all those loans, calling to mind the adage related to Bob Hope: “A bank is a place that will lend you cash if you’re able to prove you don’t require it.”
Some lending institutions questioned remarkable ability to turn their members’ heads, in terms of so long the credit union hadn’t played in the commercial market. Instead, they considered placing their effort in other opportunities, and leaving the commercial market to the present competitors.
Regardless of the reasoning, you have to answer the “what” question by succinctly stating what types of loans you’ll make to what kinds of members. Will you focus on CRE (Real estate), C&I (Commercial and Industrial), or unsecured loans? Are you confident with special or single use properties? What kinds of members will you give loan to, and therefore are they likely to have the means (capital, experience, collateral) that you’ll want to get comfortable with the credit?
With the first two questions answered, one last question would be the easiest question: “How?”
The operating model you select will be driven from your first two answers.
If you are considering MBLs they are driving yield, then loan participations are most likely your best answer. Participations require least infrastructure, with origination and servicing functions typically outsourced towards the originating bank. Purchasing loan participations provides numerous other benefits, key included in this being diversification (borrower, loan, industry, geography, etc).
With these benefits come disadvantages. Your underwriting decision can’t be outsourced, meaning your credit union must have expertise sufficient to make that underwriting call. Too, you will find yourself dependent on organizations to service the loan, including the very important task of performing annual due diligence.
As well, loan participations don’t suggest lower risk. The participations may be inside a market or industry with which your bank is not familiar, limiting what you can do to adequately evaluate and monitor potential risks.
Most lending institutions don’t begin with an in-house MBL solution, so a CUSO approach is easily the most common other structural option. An MBL CUSO allows you to offer a number of MBL services in an attractive price. As well, the MBL CUSO and its owner/user lending institutions may serve as a resource with whom to operate to easily participate loans which are too large for your bank to carry by itself.
If a CUSO is the answer, a robust RFP and research process is essential. Like a vendor, your CUSO has got the chance to make or break your member experience. In addition to the significant due diligence process, you’ll want to ensure that the CUSO you choose is sensible for the “why” and “what.”
Staffing and Marketing
Staffing levels are impelled by your loan types and operating model. Staffing needs will vary accordingly, and will also vary based on the degree of effort required to market to your existing members and your local business community.
Finally, with regard to “how,” it’s important to remember that your answer at this point over time isn’t forever. As the focus shifts and as your MBL volumes grow, you might find that morphing to a new model makes sense. That will be much easier once you have started, whatever the operating model; at a minimum, you will have gained valuable experience in MBLs as well as your local market; better still, you’ll have a portfolio of loans to transition to the next model.
One last question: “What’s next?”
With solid solutions to the “why” / “what” / “how” questions and full agreement out of your Board, the next step is to build up an MBL exploration plan. This plan should:
- Identify the answers to the three questions
- Identify targeted MBL volumes (e.g. quantity of borrower relationships, loan volumes by type) and proposed exposure limits
- Identify risk impact in the planned MBL approach, and identify relationship with organization’s risk appetite (or create organizational risk appetite, if necessary)
- Identify participation channels or potential MBL CUSOs, as applicable
- Address staffing additions
- Address training and education needs for Management and also the Board
- Highlight decision criteria and timelines
- Identify high-level actions to enact, if so determined
As you explore MBLs for your members, understanding the correct questions you should ask are the first step toward getting the right answers. By asking and answering these three questions, I have without doubt you’ll develop the best answers for the credit union as well as your members!