Automated decisioning engines and staff members who are good advisors may both play a role.
The rising interest rate market means spreads are back—and credit unions, like other financial institutions—will be looking to make loans. However, rising rates also mean the end of the mortgage refi boom of the past several years and might just slow down car buyers too. Business loans banking might be an area to look at with renewed interest right now.
In the 2022 What’s Going on in Banking survey conducted by CUESolutions provider Cornerstone Advisors, Scottsdale, Arizona, 56% of bankers said that small business loans were key to their success, just under commercial and industrial loans at 57% and significantly higher than commercial real estate loans at 37%. For credit union executives, small business loans were the fifth most important loan priority at 34%, outpaced by mortgage/refis at 75%, auto at 63%, home equity at 56%, and commercial real estate at 45%.
With business lending more front and center again, what’s the best approach?
In its Oct. 25 Backstage Pass newsletter, Cornerstone suggests that to make lending to small and medium-sized businesses affordable, “institutions need to rely on credit decisioning engines rather than human underwriters to do the heavy lifting for qualification.”
What is ironic about this approach is that these loans are being approached on a commoditized transactional basis. The fastest, cheapest combo wins. The probability to repay the loan is based primarily on borrower credit scores, and they in turn are based primarily on historical bill-paying performance.
Trusted Business Advisors
But the technology alone is likely not enough.
When we ask business owners what they would like to get from their business lender, they typically respond by saying they want to get help from a knowledgeable business lender who possesses some expertise about what it takes to run a small to medium-sized business.
They are not asking their lender to run their business for them, but they would like to have a viable sounding board with which they can discuss their business plans. They are looking to get responses and input from someone who understands business model structure and can help them learn how to make better business management decisions.
The CUES School of Business Lending is designed to help credit union staff members engaged in commercial banking become business model structure experts who can build a relationship with business owners based on trust and mutual understanding. We want them to be capable and confident so they can talk with a business owner about how to be successful, both with business in general and with a business like their own.
The curriculum shows participants how to assess business entity financial performance based on a knowledge of entity structure characteristics and industry sector business model architecture. Loans need to be granted in amounts and term structures that are operationally cash flow affordable to the borrower.
This is not just software-based plug-and-chug decisioning. It requires the borrower and the lender to be on the same page and a good sense of where the business is going, in addition to having a historical performance perspective. Last year’s performance will not pay a loan back that you book today. Future performance will enable the repayment. The challenging question is, “What kind of future operating performance, given the structure of the business model, will be required in order for the borrower to be in a position to repay the loan?”
Setting Up for Success
Generating sales in any business requires a business owner to have a unique mix of assets to enable sales to take place. Assets sit on a business balance sheet that, by definition, has to balance. Every $1 of assets acquired by a business requires $1 of capital to fund the acquisition.
The funding structure has to result in a reasonable return on investment for the business owner(s) and an operating cash flow capacity to service any debt capital provided by creditors. Reality says that the lender is a primary architect of the funding structure.
Key questions lenders need to ask themselves include: Are we capable of identifying and structuring the right types of loans in the right amounts to serve the identified needs? Is the proposed term structure of the loan(s) we’re offering going to result in the borrower being capable of repaying in the normal course of business?
If you are hoping to build out your lending program for small business, you need to be able to answer these questions.