Summary: While banks are focusing on C&I lending versus their past concentration on real estate, many lack the skills, structure, and lending culture to succeed in this area.
In our last newsletter, we wrote about the transition that is occurring at many banks from an emphasis on commercial real estate lending (CRE) to C&I loans. Until the recent downturn, at many banks CRE represented 60 percent of all commercial loans. As noted last time, a CRE emphasis existed because of at least four reasons: “easy” origination process (meaning that many CRE deals were in the market looking for financing), attractive returns, strong track record, and a belief that CRE loans could be liquidated, if necessary.
Obviously, the lending environment has changed. Many CRE loans are in arrears and most banks neither expect nor want to grow that portfolio. The pendulum has swung from CRE to C&I lending. However, many of the banks we know are putting remarkably little thought into the people, products, support, infrastructure, and/or partnerships required to be successful at C&I lending.
Shifting to C&I lending.
C&I lending requires a more rigorous and detailed approach to account management versus CRE lending:
* Loan monitoring. Depending upon the loan structure, C&I loans require monthly, weekly, sometimes even daily monitoring. The lender needs to understand cash flow lending and be comfortable interacting frequently with the borrower.
My first weeks as a new lender at Citibank, many years ago, point out the approach that is required. I received a call from one of my customers who wished to draw down on his line. When I went to my Team Leader to obtain his signature, he wanted to know why the borrower needed the funds and when he intended to pay them back. C&I lending requires an intense understanding of the customer. Of course, as it turned out, so did CRE lending.
* Collateral management. In many cases, inventory, accounts receivables, or other assets provide both the support for making the loan and the main source of repayment. Historically, many banks have made working capital loans without the proper procedures to safeguard the bank. Going forward, we expect less of an emphasis on loans made with blanket UCC-1 filings. Rather, borrowing bases will become more prevalent as part of a loan’s structure.
* Profitability. When they were performing, CRE loans generated stand alone profitability, based upon their rates and fees. C&I loans often require a degree of initial and ongoing due diligence that severely erodes the profitability of the loan itself. Therefore, relationships, cross-sales, capturing the owner’s and employees’ business become a critical profit component. However, banks do not do very well at relationship building or cross-sales.
Six actions to consider.
Banks focusing on C&I ending should consider the following actions, among others:
1. Hire for the job. Many banks are following the path of retraining existing staff to become C&I lenders. However, the skill set differs substantially and in most cases retraining will fail.
2. Decide what type of C&I lending to focus on. C&I lending includes term loans, unsecured loans made with the support of a personal guaranty, and the heavily monitored transactions noted above. If executed well, any of these product approaches can work. What will not work is to have a bank sticking its toe into a product area (for example, collateralized lending) with which it is not comfortable.
3. Decide what size facilities you will specialize in. For example, the opportunities with and approaches required for micro-lending are significantly different than with companies borrowing more than $250K. Each segment can be profitable with the right execution.
4. Assess your internal capabilities. Many banks lack sufficient capabilities related to collateral monitoring. They either need to hire in that skill set, avoid those types of loans, or partner with third parties.
5. Keep good records. Banks should be prepared for even more scrutiny by governmental agencies desiring to increase lending to small and mid-sized businesses.
6. Learn to partner. Almost every bank we know can recount a story concerning how a relationship with a third-part did not work. Similarly, vendors can tell unlimited horror stories about working with banks. In this environment, however, it is in a bank’s best interest to make third party partnerships work. Here are a few examples related to C&I lending:
* Loan management. Companies such as FTRANS work with banks to manage the working capital lending process. In effect it outsources the accounts receivable process for a bank. Its activities include credit administration, collections, and payment processing.
* Disposition of collateral. Most banks avoid assuming and disposing of collateral. Companies such as Nassau Asset Management work with banks and equipment finance companies to conduct, in their own words, “collections, asset recovery, remarketing, plant liquidations, and appraisals.”
* Equipment finance capabilities. Some community banks have decided to outsource specialized product requirements to third-party experts. A number partner with TCP Leasing of North Carolina. In effect this company offers a turnkey leasing solution for the customers of its community bank clients. It helps to sell to a bank’s customers, assists in determining the best product and, with the bank, develops the optimal transaction structure.
Linking up with a company like those mentioned above will provide many banks with new capabilities and a heightened sales focus. While the tendency is to rely on internal capabilities, many banks will benefit from this type of outside stimulus rather than trying to push current resources into roles they cannot or should not fill.
Concluding comment.
Most banks must establish C&I lending as a core capability, if they are to serve their customer base and achieve growth. Personnel selection, compensation practices, product mix, and risk management capabilities are but some of the areas that community and regional banks need to assess and improve, if they are to compete effectively against larger players in the C&I space.