Opportunity or Threat? A Candid Discussion About the Proposed Ability of CUSOs to Originate MBLs
Manifesting its ongoing support of member business lending, the NCUA Board has proposed several changes to its Member Business Loan (MBL) rule. One of the proposed changes would permit Credit Union Service Organizations to originate business loans. Some would view this change as a powerful tool in allowing the credit union industry more flexibility in its ongoing efforts to support the underserved segments of the American economy by providing new sources of capital to small businesses. Others might view the proposed change with trepidation, urging caution to credit unions to avoid the serious mistakes committed by the commercial banking industry in its move to improve economies of scale through the centralization of small business credit delivery. Both views have merit and, in my opinion, both are valid. The challenge that this new opportunity presents lies in balancing the benefits of economies of scale, enhanced member service, and sustainable growth and profitability with the clear focus needed to avoid the same industry-crippling mistakes committed by commercial banks. Simply stated, credit unions cannot enjoy the benefits of centralization of loan origination, document preparation and loan servicing within a CUSO environment at the expense of sacrificing the development of a skilled infrastructure of talented commercial lenders. Let me explain: In the early 1990s, 17 of the nation's largest banks met on several occasions with Risk Management Associates (better known as RMA, formerly Robert Morris Associates) and Fair, Isaac Company - the pioneer vendor of credit scoring technology. In addition to the early development of the first pooled small business scorecard for credit scoring purposes, several significant changes to traditional small business lending arose as a result of those meetings. Banks became aware that small business lending is expensive - and the studies indicated that the average fully-burdened cost of originating and funding a small business loan is $2,500. Reacting to this revelation, large banks throughout the country began to take steps to cut costs and centralize the lending process. Lending authority was stripped from branch managers and loan officers. Centralized loan processing centers were developed in order to improve the economies of scale by reducing the cost and turnaround time of credit evaluation and financial statement, tax return and cash flow analyses. Automated credit decision support was implemented and branch offices became more sales oriented and less burdened with labor-intensive credit underwriting analytical duties. Everything - credit evaluation, financial statement analysis, credit decision, loan document preparation - was done in a centralized environment.and the model worked. Loan decisions were made faster, the internal cost of credit delivery was reduced, small business loan portfolios began to grow rapidly, and life was good. Or was it? With net interest margins growing, loan decision turnaround time becoming more competitive and business services market share expanding, commercial banks systematically shut down their commercial lending training programs. After all, why go to the expense of training branch personnel with the skills involved in financial statement analysis and business credit evaluation, if loan decisions were being made in a centralized location? In addition, commercial banks focused their attention on high-end small businesses and middle-market companies that represented much higher borrowing demands and a broader need for deposit, investment, trust, cash management, payroll, retirement, and other fee-based services. Facing the requirement to service business customers with fewer trained employees, banks moved away from providing full, "high touch" service to SOHOs and small businesses with borrowing needs of less than $250,000. To be sure, capital was still available through automated credit decisioning processes, but personal service and "relationship banking" was a luxury afforded only to larger businesses. To make a long, sad story short, the end result - a real problem that faces all business lenders today - is a chronic nationwide shortage of qualified commercial lenders. When the largest banks' internal credit training programs disappeared, so did the bench strength of small business lending. With it, came increased reliance on third party alliances and resource leveraging - ironically, two prime strategic benefits of CUSO member business loan origination. So here we are, confronted with the opportunity to provide high-touch service to very profitable member business relationships, and faced with the option of whether or not to leverage the member business lending initiative through a CUSO as the proposed regulations would provide. Counter Intelligence Associates is currently involved with the development of several multi-credit union owned CUSOs - some in the early stages of discussion and some that are ready to be launched as limited liability companies that will provide credit analysis and underwriting expertise, loan document preparation, loan servicing and loan participation management services for their credit union-owners and other credit union users of these services. Under the right circumstances, the economies of scale of multiple credit union-owned CUSOs created for the efficiencies of delivering member business credit clearly outweigh the soft and hard-dollar expense of going it alone. As successful as these models are, I caution every client with the following: every credit union owner or user of CUSO centralized member business loan underwriting services must commit to the internal development of the skills necessary to analyze, evaluate and underwrite member business loans. The credit union industry has the opportunity of creating the nation's largest, and most efficient provider of lending, deposit, cash management and other services to a growing and profitable segment of the small business market that has been abandoned by other lenders - but we cannot make the long term mistakes that others have made before us. Efficiencies of third-party outsourcing aside, we must develop and expand the internal credit skills necessary to sustain a self-supporting new line of business. We have to commit to the development of new and exciting career development paths through the continuous training of our own employees. The CUSO MBL opportunity then also becomes a valuable MBL training opportunity. A business lending CUSO owned by one or several credit unions can become their career development facility through the implementation of internship programs that will help develop the hands-on commercial lending skills of individual employees while providing the credit analysis resources needed by the CUSO. "Off the shelf" credit training programs are available and custom programs designed to develop skills in understanding basic business accounting, the structure of business financial statements, the relationship between the profit and loss statement and the balance sheet, cash flow analysis and projection, key performance ratios and other indicators, accounts receivable aging, legal structure of various business types, and other business lending skills, can be developed to match the needs of each organization. The key to blending a successful MBL initiative with the CUSO opportunities presented by the proposed changes to Rule 723, is to understand that reliance on a CUSO simply as a credit processing centralization vehicle, without making a commitment to the ongoing development of internal skills in member business lending, will only take us down that same path that has created a chronic shortage in commercial loan underwriting skills throughout the financial services industry. We cannot afford to use this opportunity to ultimately weaken our business credit underwriting infrastructure; rather we must use the proposed change that will allow CUSOs to originate member business loans as a tool to create new economies of scale and develop and enhance an industry-wide qualified, skilled foundation of business lending professionals. In the long run, the benefits to both the credit union movement and the American small business economy will be profound.