Lending Competition: New Rivals Woo Small Businesses
The Great Depression and the decades leading up to it forced many to look beyond their comfort zones just to be able to survive another day.
Be it a bartering system that exchanged services for bread and fruits and vegetables or a small group of factory workers pooling their wages to form a lending system after being shunned by banks, survival became the impetus.
Despite the intense heat on credit unions and business lending these days and the critics who condemn their efforts to expand saying the moves are too risky to undertake, cooperatives have been offering business loans in some shape or form since the movement formed in the United States more than a century ago.
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It was not until 1987, however, following several credit union failures due to business lending, that the NCUA promulgated regulations specifically targeted at this type of lending, according to a 2001 Department of Treasury report.
After the NCUA revised its business lending regulations in 1991, the quality of credit unions’ member business lending portfolios grew stronger through the 1990s, Treasury said. As of June 30, 2000, member business lending delinquencies stood at 1.84% compared to 8.20% as of year-end 1993. Today, the rate is hovering around 1.5%.
With stronger safeguards in place, more credit unions began to enter the business lending space. Along with that new presence, the industry began to compete squarely against community banks, many of which shared similar operational models that emphasized local decisions. To this day, they continue to be credit unions’ biggest competitors.
“Community banks are traditionally the biggest and toughest competitors for credit unions,” said Larry Middleman, president /CEO of CU Business Group, a business lending CUSO in Portland, Ore., that serves nearly 400 credit unions. “A lot has happened if you go back six years. The last three years were the go-go years for credit unions because everyone was retrenching and pulling back and becoming non-competitors.”
Middleman said while larger, national banks are not a huge competitive threat dominating the market, they have a product packed with technology features – a lure that appeals to many small business owners.
Still, a sweet spot for credit unions is courting and building long-term relationships with businesses that have 25 to 50 employees, Middleman said.
“It’s been pretty easy for credit unions to do,” he noted. “But to pull in the larger businesses, competing with community banks has always been tough.”
One of the industry’s newest competitive threats is Costco Wholesale Corp., Middleman has noticed. As of 2011, the warehouse club chain based in Issaquah, Wash. had 520 locations in the United States, United Kingdom, Canada, Australia, Mexico, Taiwan, South Korea, and Japan, according to company data. Costco has several partnerships that bring services to small businesses, often at inexpensive rates, Middleman said. For instance, the warehouse club has a merchant bank card alliance that has been going strong over the years, he added.
“Pricing is cheap but it’s tough to get a lot of service,” he explained. “They’re cheap so you get what you pay for.”
Another competitive nuance has been spotted right at home within the industry: credit unions and CUSOs competing more with each other. Middleman said the competition has ramped up over the past two to three years. If there’s a CUSO that serves credit unions in a state or larger region of states, several credit unions could be competing for the same loans in the same marketplace.
“It poses an interesting quandary and if two of them work with the same CUSO, that can also be interesting,” Middleman. “If you have three credit unions that own a CUSO and all three are in on a particular deal and you have ownership, how do they all handle that?”
As a general rule, CUSOs may ensure that each deal is handled independently and information is not shared to avoid any potential loan overlap in the same locale, Middleman said.
“With respect to credit unions competing in the same market, I think it’s a really good thing,” he offered. “They all have a common goal of how to treat their members. The underwriting is usually fairly conservative.”
The aberrations may come with a deal such as a $5 million commercial office building when community banks, larger banks and life insurance companies are all vying for the same transaction, Middleman said. It might be a 10-year, fixed rate loan – transactions that credit unions tend not to do, he noted. As a result, they often lose out of the deal to their competitors.
Indeed, insurance companies are looking to carve their niche more in commercial lending due to the partial demise of commercial mortgage-backed securities, said Pete VanGraafeiland, vice president of business lending at the $2 billion Coastal Federal Credit Union in Raleigh, N.C.
Because of the type of loans that the cooperative does and the territory Coastal FCU is in, many of the insurance companies were paying product from CMBS, typically called a conduit, VanGraafeiland said. When they ran into trouble with their mixed used portfolios, many people lost faith in them, he added.
“Conduits just went away, some were shut down and some put their product on the shelf,” VanGraafeiland said. “There was little competition in that arena. There was some competition from the national banks.”
With a track record of commercial lending, Coastal FCU doesn’t get a lot of competition from community banks “despite what the ABA says,” VanGraafeiland said. The credit union tends to do long-term deals between seven and 15 years. As a result, the most aggressive competition comes from insurance companies, credit companies and surviving or reinvigorated conduits. Over the last two and a half years, the conduits have ramped up their hiring and their parent companies have started to breathe new life into those that were dormant for years.
“Some of them are pure real estate lenders but they might be more conservative with a 65% to 75% LTV range with much lower rates,” VanGraafeiland said. “Others want to do investment grade deals. They are very aggressive with an 80% LTV, 30-year amortization and very low debt service coverage. We can’t compete with them because they’re doing very big deals. They’re up there in the ionosphere.”
Beyond physical competitive threats, VanGraafeiland said regulations may stifle the credit union industry’s ability to compete; most notably, the 12.25% of assets member business lending cap. In February, Coastal FCU was $2 million from its cap. A sell-off of some loan participations provided some breathing room. “It’s a daily occurrence to keep us out of the ditch,” VanGraafeiland said.
Another regulatory disappointment for some medium and larger credit unions was the cancellation of RegFlex, he noted. Well-capitalized MBL lenders have to go through all kinds of regulatory steps to get a waiver for certain types of loans. VanGraafeiland said the process is very time consuming and credit unions tend to miss out on many high quality loans.
As the business lending scape continues to evolve with new players coming on the scene, that transition may not be the biggest threat. The recent implosion of business lending programs at Texans Credit Union, Telesis Community Credit Union and others may have caused some credit unions to shift their way of thinking.
“I’m starting to get more inquiries asking ‘how do we build our own platforms,’” said Steve Sala, principal with SFE Advisors, a consulting firm that does workouts, counsels senior management through execution of corrective action orders and serves as a third-party loan review function for credit unions and banks.
“There are a lot of concerned credit unions and CUSOs scratching their heads,” Sala said. “A lot of people are saying ‘what are we buying into if we go down this road.’”
Sala said SFE Advisors was hired to work through the troubled business lending portfolio at AEA Federal Credit Union, which made headlines recently when its former business lending vice president was convicted of fraud for a kickback scheme that led to the cooperatives’ conservatorship and near collapse. Sala was called on as a witness by the Department of Justice in the recent trial in Arizona to convict William Liddle, his wife, and Frank Ruiz, a real estate developer involved in the scheme.
“Culturally, there is a difference between banks and credit unions,” Sala said. “A community bank doesn’t typically farm it out. If they want to do business lending, they will hire a commercial lender. Yes, it costs more. Where do you find these people -- across the street at a bank. This is where things come to a screeching halt with credit unions.”
Many credit unions may not be able to offer the high salaries that former bank commercial lenders are accustomed to. Sala said they also tend to promote from within, which can create a roadblock to compete because that new lending officer may not have the expertise to take the loan program far.
“The best way to get the best person is hiring someone who’s been to the university of hard knocks, someone who’s been through the battle,” Sala said. “During the good times, credit unions might say ‘how hard can this be.’ But during the bad times, the hardest part is getting out of a bad loan.”
Sala said credit unions have much to offer small businesses. However, they can sometimes be their own worst enemy.
“There is a wonderful space for credit unions to play in without a lot of competition. But they show up at a buffet with big eyes and want to put everything on their plate,” Sala said. “Then they sit back and say ‘what do I do now.’ People get outside of their sweet spot of what they do well. If you ‘re a long-term thinker, you’ll be better served to hire the right talent and develop your own platform.”