Executive Summary: The current business environment makes new lending problematic, as many traditional products provide limited growth. However, now is the time for management to evaluate and prepare for selective “niche” opportunities that are appearing as the economy stabilizes and revitalizes. Bank executives can use today’s lull in “traditional” lending to identify, educate, and institutionalize specialty skill sets that will position their banks as market leaders in specific niches both locally and, potentially, nationally.
Consider Niches for Success.
In today’s operating environment, being a generalist C&I or CRE lender is probably a ticket to failure. Origination and underwriting costs are increasing, even in this environment competition for “vanilla” credits is growing, and, as in the past, market differentiation will be difficult to achieve.
The value of niche leadership is at least fourfold. First, establishing your bank as a specialty lender can build market awareness and enhance credibility with borrowers, reducing your origination costs. Second, segment-specialized expertise should allow a lender to recognize and anticipate risks better than a generalist, thus making the institution more adept at quickly recognizing portfolio issues, mitigating those risks, and optimizing portfolio quality. Third, specialized lending often allows for premium pricing, a critical factor for banks facing challenges to their ROEs and ROAs. Fourth, the value added, that your specialized lending can encourage the sale of fee-based products, enhances a relationship’s yield.
Developing niche leadership begins with strategic management.
Management should establish a process to determine those niches it should exploit, as well as those it wants to avoid. A roadmap should include the following steps:
* Evaluate your current portfolio. As a starting point, self assessment uncovers niches in which you already operate, sometimes in limited geographies or perhaps even unknowingly. For example, a prior client found that one of its regions had developed a strong expertise in transportation related lending. However, other regions were largely unaware of the capabilities already existing in house. In another case, a client was distressed to find the number of customers he had operating in what he viewed as a particularly unattractive industry.
Banks evaluating their portfolios need to consider: Are there existing concentrations that can be promoted? Which ones show above-average profitability? And which show profitability potential that could be realized through cross-selling?
* Determine priority niches. Niche opportunities go beyond industry and size. We have seen companies segment their lending focus on various characteristics, including: cash flow volatility, asset stability, stage of lifecycle, international requirements, bank product type needs, and management success.
The choices for niches in which to operate are multiple and proliferating, For instance, industry segments include more traditional manufacturing activities and “green” and technology companies. Management should base niche selection not only on market potential and sustainability but also a frank evaluation of internal culture and capabilities. All too often banks think they are providing a “unique” value proposition when in fact they are selling largely indistinguishable services. As discussed below, the nature of a niche approach is that its customization identifies it with its target.
* Assess the bank’s existing talent base. Banks that focus on a niche require personnel with extraordinary risk management knowledge of the selected segment. That is fundamental to but not sufficient for success. They also need bankers who know the marketing and operational challenges of the industry and should be able to offer competitive non-credit solutions.
That sounds like a tall order, and it is. It requires investment in personnel and a refusal by management to settle for the employees it already has rather than to seek the best.
* Refocus for niche leadership. The classic bank industry “business system” includes origination, underwriting, operations, ongoing risk management cross-sell, collections, etc. Each of these activities needs to be reconsidered with the selected niche in mind. For example, with some niches, marketing activity may require involvement in key industry associations both for establishing contacts and credibility. Traditional bankers may need to be replaced or supplemented by representatives from the targeted niche.
In particular, the risk management process may need to be changed and strengthened. To really understand a niche, a bank needs to know more than just its numbers. It will be vital to understand the dynamics of that market as well. How reliable are customers? How fluid are competitors? What impact does (will) regulation have? Is technology a friend or foe – or both? Are suppliers safe? Again, staff with in-depth and insider knowledge of the industry may be able to provide questions and issues that go beyond traditional analysis.
Whether through insiders and/or interviews, banks need to develop an understanding of the factors driving the business: What is important for building a successful business in this particular niche? What do entrepreneurs overlook when they begin? What trips them up later? What causes cash flow volatility, shifts in asset stability, and operational issues?
Concluding thought.
Generating organic asset growth presents the banking industry with one of its greatest challenges. Quality loan growth is available to banks, but they need to be selective in whom they market to and how they position themselves with their targets. Management should consider an objective self assessment and detailed preparation as starting points down this path.