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Is the Light Green or Yellow?

May 2014 – Vol: 37 No. 5
by Richard H. Gamble

CUs weigh taking a bold or a cautious approach to member business lending.

Red (with man standing), yellow (with man walking) and green (with man running) stoplightsWhen 29-year-old Brittany Hart had a chance in 2011 to buy the building that housed her beauty salon in Florence, Ala., she applied for a loan at her bank. Quickly and without explanation, she was turned down. So she tried three other banks. Same story. When she talked about her discouragement at the shop, one of her clients suggested, “Call Denise over at the credit union.” So she did. It took a couple of weeks, but she ended up with a $240,000 mortgage loan that bought the building and a $30,000 secured line of credit. Then she moved her personal bank accounts to the CU.

The personal touch still works. To some degree, a CU can succeed in member business lending just by doing what comes naturally, with existing resources. For the more ambitious, building a strong commercial loan portfolio takes fundamental changes—new people, new services, new budgets. Whether to go big or go small in member business lending is a hot topic today at many CUs.

Hart’s business loan is with $630 million Listerhill Credit Union, headquartered in nearby Muscle Shoals, Ala. Listerhill CU recognized member business lending as a line of business about nine years ago, estimates Daryl McMinn, chief operating officer, but it eased into the business cautiously.

Instead of hiring an experienced bank commercial lender, for example, it approached two consumer lenders already on staff who were eager to learn new skills, and sent them to training. (At that time, the CU used a third-party underwriter to meet National Credit Union Administration requirements.

A little over a year ago, Listerhill CU did hire an experienced banker to head up a business that now accounts for $66 million in commercial loans. While Denise Jones, AVP/commercial lending, one of those original consumer lenders, reports to the new executives, she remains the face of the CU’s business outreach to many of its clients.

Cautious Success

Listerhill CU offers a fairly full menu of business loans, McMinn reports, but $56 million of the portfolio consists of improved real estate loans. “We’re cautious,” he concedes. Listerhill CU reached modest success as a business lender with little investment in marketing, technology or staff. “In northwest Alabama, if we please one business customer, others in that same line of work will find their way to us,” McMinn says.

Deposit services remain basic. “Our core system doesn’t support some of the sophisticated deposit services members desire,” he explains. “We rarely originate ACH files and can’t do automatic sweeps from one account to another or into investments. We do hope to do more eventually, and we are preparing to launch a business credit card.”

Hart’s business, Salon Mod & Spa, is still small (about $550,000 a year in annual revenue), but thriving. She tapped her line of credit to renovate the spa, repaid the loan and then borrowed again to renovate a rental unit in the building. She has embraced the credit union’s online banking and regularly uses her computer to check balances and move money into and out of business and personal accounts. But she doesn’t need remote deposit.

“They have a branch two blocks away. I just walk over every other day and make the deposits in person.”

Satisfying All-American Swim Supply, also in Florence, is a greater challenge for Listerhill CU because the firm is a $4.5 million enterprise with stores in Pensacola, Fla.; Memphis and Nashville, Tenn.; and Raleigh, N.C. However, the company is also “a small-business success story because the credit union helped us get our first loan when none of the banks were interested,” reports owner Keith Haden. The company is a nationally known supplier of competition swimwear.

But with its dispersed business, All-American Swim Supply needs a bank for what it can’t get from Listerhill CU. “We have a relationship with SunTrust, which has branches near all of our stores,” Haden explains. “We use the bank to receive daily deposits from those stores and to pay rent, utilities and local payroll from those local accounts.” Listerhill CU holds the main corporate account, he explains, and money can be moved online to and from the store accounts to the Listerhill CU account, but the process is manual, not automated.

“The Listerhill infrastructure has limitations, but we have found a solution that works,” he concludes.

Credit, all from Listerhill CU, is crucial, Haden says. “Our businesses have fluctuating cash flow, so we need operating lines of credit to meet their needs and continue expansion. We have a growth initiative in the planning stages that will take funding. We’re working with the lenders at Listerhill to put that together. They understand what we need and are good to work with.”

Bolder Success

For all its success, Listerhill CU is a small credit union playing small ball in a small market. Credit unions that are more ambitious about their member business lending may need more infrastructure. Identifying a member with a business credit need, understanding how that business works, applying good underwriting practices, then structuring, pricing and booking the loan puts just one leg on what needs to be a three-legged stool if a credit union wants to have a stable, enduring program, says James R. Devine, CEO of Hipereon Inc., a Redmond, Wash., consulting firm. He’s also a lead instructor for the CUES School of Business Lending.

A second leg should be credit administration. “Once you’ve booked a business loan, you’ve taken the first step in a demanding process,” Devine says. “The work is relentless over the life of the loan. A lot of CUs that are making business loans still need to work on their credit administration. You need to anticipate problems and start remediation while there’s still time to fix things. Even a large or mid-sized CU can struggle to keep production humming and still supply anticipatory credit administration. Problem loans can eat up a lot of time.”

Staffing is a huge issue. Many banks and some large CUs have separate staffs for creating credits and for managing and collecting them, but CUs are more likely to use the people who make the loans to administer them, he reports. “They necessarily divide their time,” he points out.

The third leg of the stool should be depository and cash-management services geared to small businesses, Devine says. “Otherwise, a business will have to split its business, using a bank for operating services and a CU for credit. “The way to really succeed with businesses is to build a package of credit and noncredit services that meet business needs. Remote deposit capture, lockbox services, even controlled disbursement can be effective. If you only provide one piece, your success will be limited.”

Outsourcing can be a quick way to add business services, but there’s a down side, Devine cautions. “You want to gain the confidence of your business members, and confidence goes with know-how. If they see that the know-how belongs to some third party they’ve never met, it undermines their confidence in the CU.”

Tough Competition

Credit unions considering a foray into the business lending market should be prepared to face particularly tough competition, Devine warns. The easy days came in 2007-2011 when banks were “forced to the sidelines” because of their credit problems, and credit unions got walk-in business from business owners who were looking for replacement lenders. Now banks are back up off the floor and aggressively trying to take back that business, and credit unions that stacked up business loans during those years find themselves in the cross-hairs, Devine says.

Bank of America can come in and offer to refinance a 5.75 percent loan at 3 percent with no fees, he illustrates. Federal credit unions are banned from putting penalties for refinancing and early termination in their loan agreements, so the only way to keep some of those loans is to cut rates to meet the competition. “We’ve seen a lot of erosion in CU loan portfolios in the past 12 months,” Devine recounts.

Success is still possible, but it will grow out of deep relationships, not swings in market conditions, he advises.

“Go after existing members who operate businesses,” he suggests. That means identifying which members run businesses, something only a few leading credit unions have done so far. “Concentrate on the small loans—under $500,000—to businesses whose owners hate the commoditized approach of banks.”

Competition with banks is often exaggerated, argues Patrick La Pine, CCE, president/CEO of the League of Southeastern Credit Unions, Tallahassee, Fla. “CUs often complement banks,” he insists. “Some CUs tell us that banks refer borrowers to them” because banks don’t want to make the $200,000 loan to the guy starting a lawn services business who needs money to buy a mower and a trailer.” And borrowers on that scale usually don’t need sophisticated noncredit products.

There’s good reason for credit unions not to be too ambitious with their business lending, La Pine points out.

“CUs can only make business loans now up to 12.25 percent of assets. If you’re successful in business lending, you can hit that cap pretty soon. We’re working to get it raised or lifted completely, but there’s a real danger that you could staff up for business lending and invest in infrastructure and then hit your limit before you can recover your investment.

“You could help a new company get started and then have to bow out of the second round financing because it’s over your limit.”

But if you want to keep the business of a growing company, you’ll probably have to offer more services than credit—or risk losing the business, he adds. “It’s an issue to consider carefully.”

$825 million Texas Trust Credit Union in Mansfield is one credit union that is rethinking its business lending ambitions. “We’ve pulled back and now are focused on smaller loans—under $1 million—and we’re targeting owner-occupied real estate like buildings for doctors, lawyers and insurance agents,” reports CUES member William Kelsey, CSE, CCE, EVP/chief operating officer.

“In light of the economic challenges, a lot of our old goals are out the door,” he reports. “Our commercial loan portfolio used to be $80 million. Now it’s $49 million. We used to buy participations to grow our portfolio, but we’re exiting that business. We’re taking a fresh look at who we are.

“The time and effort used to evaluate participations is being refocused on our market efforts,” Kelsey explains. “We are targeting the local businesses to be their one stop shop for all their financial needs. We see opportunities in our market, with local business owners telling us they want to work with a financial institution where the decisions are made locally and they can come in and visit in person.”

Texas Trust CU may have taken a step back, but it’s still looking forward. “We’re upgrading our services,” Kelsey explains about the CU’s efforts to add payroll and remote deposit services geared to businesses. One HVAC business gets paid by check on locations and would like to use remote deposit to immediately send images of those checks to the credit union for deposit, he reports.

“We want to have the full-deal meal. When we do, we think we can make things happen. When we get a business relationship with an employer, we can bid for the employees (as credit union members). That,” Kelsey insists, “will be a win-win.”

By doing business loans, Listerhill CU probably has gained a customer for life in Hart and gained a vocal supporter in Haden.

“I can pick up the phone and call Denise or even the president (Brad Green),” Hart says, “and they’ll know who I am and what loan I’m talking about. My previous bank could never do that.”

“We’re a local company with an international business and reputation,” Haden boasts, “and it never would have happened if a credit union hadn’t taken the time to listen to us, understand our vision and partner with us to make it work.”

Peter Duffy, managing director at Sandler O’Neill, New York, says credit unions should do business lending only as part of a strategic plan, not a tactic to build earning assets.

“It’s hard to imagine a community financial institution surviving in the long term without being involved in small business lending,” he adds. “It has to be part of your earnings, capital accumulation and growth plan. And it needs to help you diversify. The market pressure on consumer lending will not abate, so the need to diversify will only continue.”

Richard H. Gamble is a freelance writer based in Colorado.

NCUA: Green Light With Speed Limits

To the extent that U.S. credit unions’ federal regulator controls the traffic signals for member business lending, the light is definitely green—with posted speed limits. When it comes to credit quality, CUs have performed better as business lenders than banks, notes Tim Segerson, deputy director of examinations and insurance at the National Credit Union Administration in Washington, D.C.

Member business loans improve asset diversification, offer better net interest margin than investments and allow CUs to penetrate their member base more fully. They also encourage small business formation and expansion, Segerson points out. Even with conservative underwriting, growth has been solid, he reports.

“They’re not having trouble finding borrowers,” he says of credit unions. “Growth last year was pretty strong, in line with recent prior years.” Call report data from 2013 indicate that MBLs grew by 9.6 percent in 2013, notes John Worth, NCUA’s chief economist.

Where CUs cause NCUA a little anxiety is not in MBL underwriting, but in the follow-up, Segerson says. “Some still bring a consumer-lending mindset, ‘set it and forget it’ thinking. Business lending requires managing a relationship. You can’t run business loans like credit cards, just by the statistics. It only takes a few troubled business loans to hit critical mass.”

Among all CUs, MBLs grew from $23.5 billion at the end of 2007 to $43.42 billion at the end of 2013, almost doubling but still a tiny fraction of total loans, Worth points out. And more than two-thirds of CUs still make no MBLs. Among those that do, 88 percent are secured by real estate, he notes.

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