Lenders need to be prepared for continual and often rapid shifts in the economy.
One such change is increasing interest rates, an abrupt wake-up call that is occurring. The average rate on a 30-year fixed mortgage, for example, for the week ending Sept. 13 was 4.5%, compared to 3.53% in May, according to the Mortgage Bankers Association.
One effect of this jump of about 100 basis points in just six months is the winding down of the refinance boom.
Banks and credit unions tend to react to developments of this sort with different strategies. Large banks have been shedding mortgage staff since 2012. JPMorgan announced in February that it would eliminate several thousand jobs, mainly in mortgage servicing, by the end of 2014.
This is a traditional bank path—add staff during boom times and deliver pink slips during down times.
Credit unions, though, are averse to laying their employees off. Those that offer real estate and auto loans with fixed rates face a dilemma, however, when rates climb. If interest rates go up just 1%, the auto loan portfolio—on life support these days—suffers, especially when margins are tight. Typically they hover around 1% or 2%.
It would also be a problem for commercial real estate. If the loan was made at 4.5%, margins would be cut dramatically.
One option that holds promise for lenders is offering business loans. The time to do so is now while margins continue to slide downward and ROA limps along—credit unions with SBA business loans earn a net ROA in the neighborhood of 3% to 5%.
The costs of developing business lending can be considerable; this can be a barrier to entry. It costs an estimated $300,000 to $500,000 annually to fund a business development unit with qualified commercial lenders and support staff. Most credit unions lack the consistent sales volume to support this ongoing fixed expense.
Using the services of a CUSO can help with these costs. Instead of a large fixed cost to support the salaries, a credit union would pay about $40,000 annually and pay only for the services needed. With a CUSO, a credit union can transfer fixed costs to variable costs that can mitigate the changing economic climates that plague traditional large fixed cost lending departments.
Unlike other lending products, there is a constant demand for small business loans. These expanding enterprises need capital to survive and flourish. About 98% of enterprises in the US are considered small businesses; there are about 29 million small businesses in the US.
A small business is defined by the Code of Federal Regulations as:
a manufacturer with fewer than 500 employees;
a wholesaler with fewer than 100 employees;
a retailer with fewer than $7 million in annual gross sales.
Some 85% of credit unions that offer small business loans are focused on commercial real estate. This has been an essential need for small business following the migration out of this deep recession. However, this market has already begun to wane. Progressive credit unions should be focusing on other small business capital needs such as working capital, lines of credit, equipment loans, mergers and acquisitions.
Unlike car or real estate loans, business loans are offered at variable rates, typically pegged to prime plus 3%. Currently business loans are about 6%, which generates a 4% to 5% spread.
Another advantage of working with a CUSO is that some have the expertise to offer SBA loans—75% to 85% of the loan is guaranteed. And the guaranteed portion of the loan doesn’t apply to the 12.25% cap. SBA loans with longer terms are especially beneficial since the small business cash flow can be erratic. Small businesses need long-term funding with lower payments, the type of loan that traditional lenders are unwilling to make. Most successful small businesses have at least one to two SBA loans in their life cycle.
An additional option for credit unions is participation loans. This spreads the risk and costs among a group of lenders. And the participated portion of the loan doesn’t count toward the cap. By using SBA and participation business loans with a CUSO, the cap becomes a passing concern.
Member business loans also provide a high level of liquidity as there is an active secondary market to sell these loans, often at a significant premium.
Perhaps the most important reason is to serve your entrepreneurial members and helping to rebuild the American dream.
Kent Moon is CEO of Member Business Lending, LLC.
Contact 801-230-1044 or email@example.com