Exploring member business lending (MBLs) during 2016 was one recurring priority I heard during this year’s planning season. As management discussed that proposition, without fail, angst would follow as the credit unions considered such a significant initiative. Credit unions realize that commercial lending differs significantly from consumer lending, with some lessons still fresh from experiences during the Great Recession.
Despite those experiences, a reasonable exposure to MBLs can serve members’ needs while providing positive yield. So, why should a credit union offer business lending, what considerations must it take, and how should it go about it? It can do so by answering three simple questions.
Answer “Why?”
The first question to ask is: “Why?”
Why is your credit union considering MBLs? There are only three possible answers: to serve members’ needs, to generate loan yield, or both.
While the answers are simple, this decision point is critical. Your credit union’s “why” influences every other decision your credit union will make. That answer impacts product sets, structure, risk, staffing, financial outcome, and marketing. The answer is so critical, it’s worth asking again to make sure you come up with the same answer. Is it really about member service, or are we really just doing it to keep up with our competitors? Is MBL yield worth the increased risk we’ll be taking?
It is critical that management and the Board are lockstep on your “why” for offering MBLs. Any difference in answers between the two bodies will lead to confusion and dissension. If management wants to do MBLs and the Board does not, the Board will likely second-guess management for years to come. Conversely, if the Board likes MBLs and management is opposed, the initiative is likely doomed from the start. The bodies must agree on whether or not to pursue MBLs, and they must agree on the “why” for doing so or not doing so.
Answer “What?”
Having solved the first question, your next question is: “What?”
Just as with consumer lending, it can be a challenge to meet the Credit Union philosophy when it comes to commercial loans. The underserved member business borrowers are likely to be short on capital and collateral. Absent adequate capital and collateral (among other things), the risk on any loan increases. Being new to MBLs, your credit union might not have an appetite to serve that underserved market in a meaningful manner. In that way, MBLs to borrowers with big ideas and big dreams – but little capital and experience – represent a loan your credit unions may be unwilling to make.
If, then, you are looking to turn to stronger loans with adequate capital and collateral, you will likely find an already-crowded field of financial institutions competing for that same business. Competitors abound in most markets for those loans, calling to mind the adage attributed to Bob Hope: “A bank is a place that will lend you money if you can prove that you don’t need it.”
Some credit unions questioned their ability to turn their members’ heads, as for so long the credit union had not played in the commercial market. Instead, they considered placing their effort in other opportunities, and leaving the commercial market to the current competitors.
Regardless of your reasoning, you need to answer the “what” question by succinctly stating what types of loans you will make to what types of members. Will you focus on CRE (Commercial Real Estate), C&I (Commercial and Industrial), or unsecured loans? Are you comfortable with special or single use properties? What types of members will you lend to, and are they likely to have the means (capital, experience, collateral) that you will need to get comfortable with the credit?
Answer “How?”
With your first two questions answered, your final question will be the easiest question: “How?”
The operating model you choose will be driven by your first two answers.
Loan Participations
If you are considering MBLs to drive yield, then loan participations are likely your best answer. Participations require the least infrastructure, with origination and servicing functions typically outsourced to the originating credit union. Purchasing loan participations provides numerous other benefits, key among them being diversification (borrower, loan, industry, geography, etc).
With these benefits come disadvantages. Your underwriting decision cannot be outsourced, meaning your credit union must have expertise sufficient to make that underwriting call. As well, you will find yourself reliant on third parties to service the loan, including the very important task of performing annual due diligence.
As well, loan participations don’t necessarily mean lower risk. The participations may be in a market or industry with which your credit union is not familiar, limiting your ability to adequately evaluate and monitor potential risks.
MBL CUSO
Most credit unions do not start with an in-house MBL solution, so a CUSO approach is the most common other structural option. An MBL CUSO allows you to offer a wide range of MBL services at an attractive price. As well, the MBL CUSO and its owner/user credit unions can serve as a resource with whom to work to easily participate loans that are too large for your credit union to hold on its own.
If a CUSO is your answer, then a robust RFP and due diligence process is a must. As a vendor, your CUSO has the opportunity 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 makes sense for your “why” and “what.”
Staffing and Marketing
Staffing levels are driven by your loan types and operating model. Staffing needs will vary accordingly, and will also vary based on the level 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 in time is not forever. As your focus shifts and as your MBL volumes grow, you may find that morphing to a different model makes sense. That will be much easier once you’ve started, regardless of the operating model; at a minimum, you will have gained valuable experience in MBLs and your local market; even better, you’ll have a portfolio of loans to transition to the next model.
What’s Next?
One last question: “What’s next?”
With solid answers to the “why” / “what” / “how” questions and full agreement from your Board, the next step is to develop an MBL exploration plan. This plan should:
- Identify the answers to the three questions
- Identify targeted MBL volumes (e.g. number of borrower relationships, loan volumes by type) and proposed exposure limits
- Identify risk impact from 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 the Board
- Highlight decision criteria and timelines
- Identify high-level actions to enact, if so determined
As you explore MBLs for your members, knowing the correct questions to ask are the first step toward getting the right answers. By asking and answering these three questions, I have no doubt you’ll come up with the right answers for your credit union and your members!