In recent weeks, I have heard too often about how difficult it is for bankers to generate commercial loans. One problem for bankers is that they continue to fish in the same limited loan pool rather than look for opportunities with customers who actually want and need to borrow. Lots of commercial and consumer lending opportunities exist today. Lenders need to rethink how they lend and whom they lend to, if they want to grow volumes.
At many banks the “box” which defines whom they will lend to has become smaller. In light of the downturn, banks have limited the types of borrowers they will lend to and, in many cases tightened up the structure of those loans. At the same time many of the most creditworthy borrowers have instituted programs to limit their borrowing; they have improved their cash flow management, lengthened their payables, and taken a “go slow” approach to the type of expansion that might require financing. Many borrowers seem as wary of borrowing as lenders are of lending.
Commercial real estate (CRE) lending, once the major focus at many regional and community lenders, is now limited. This change has resulted from past credit problems, concentration issues, and, in some parts of the country, poor demand. For most banks, CRE lending will not be a major asset growth opportunity for the foreseeable future.
Therefore, banks have been looking to C&I lending as a replacement for CRE. However, “vanilla” C&I lending, that is, a lending focus without an industry or product specialization, also finds itself in difficult straits. Frequently C&I bankers find that borrowers are also reduced in number and improved in balance sheet strength. At the same time, lenders face more and hungrier bank competitors eager to bid on quality deals. In many instances, C&I lending has become a commodity product with commodity pricing…but without commodity-type risk.
While more banker sales activity can increase loan volume, it may do little to improve portfolio returns. Instead, senior commercial bank management should consider alterative marketing approaches that provide some degree of differentiation and pricing premium. Otherwise, returns are destined to decline. Below are several areas for consideration. Not all of them are right for all banks, but each is at least worth consideration by banks from the largest down to community players.
* Leasing and Equipment Finance. We just wrote the 2011 State of the Industry Report for the Equipment Leasing and Finance Foundation (ELFF). Our research found that commercial banks are rediscovering this business line. Equipment finance generates quality, secured assets; achieves higher pricing than loans; and oftentimes, can serve as an introductory product to a prospect that the traditional bank can then expand. Some of the best banks have increased the linkages between their commercial and equipment lenders, increasing wallet share and relationship profitability. In this economic environment, equipment finance can be a lead product rather than an afterthought.
* Specialized Lending. I have written before about the importance of going to market with a specialized approach, whether that involves an industry focus (for example, health care or professional services), product type (SBA lending or owner-occupied real estate), life cycle (start-ups or owners reaching retirement), ethnicity, or another characteristic. Banks may need to move a few bankers out of a generalist regional approach to focus on a specialty; however, given the potential payoff of doing so versus likely commodity returns, that is a good thing.
A specialized focus begins by a bank evaluating its current portfolio to determine the concentrations that already exist, albeit not all of them intentionally. In some cases, these unintended specialties may be viewed as toxic by the bank (retailers, construction), but in other instances they can serve as the foundation for a more intense specialty focus.
I find it hard to understand why banks do not have a sense of urgency around determining and implementing specialty approaches. For instance, during our interviews for the ELFF, we found that in most cases those companies that were achieving strong growth were doing so in large part because of the success of their specialty niche. It provided market differentiation, lowered origination costs, and allowed some premium pricing as well.
* Packaged Products. Banks say they want to develop relationships with the business owner as well as the business, but they take few actions to do so. Relatively few banks offer product suites that link the owner and the business and provide economic benefits to the business owners for bringing additional business to the bank. Owners often find this approach attractive, so why are not more bankers pursuing this opportunity?
* Third-Party Providers. Most banks lack the time and dollars to invent specialized financing products, including equipment finance. However, multiple third party providers exist that can bring expertise to a bank with zero to little investment. Note: banks need to develop an internal expertise in evaluating and managing third-party product providers. Both cost and time should push more banks to the third-party path. However, past execution mistakes and concerns about various internal hurdles often keep top management from trying approaches that could generate substantial income without substantial risk.
Examples of third party offers include:
– Asset based lending – involves secured loans based upon advances tied to a percentage of receivables and inventory. Particularly given the economic downturn, some companies that once were traditional bank credits no longer meet the criteria for standard cash flow lending. Most banks fail to offer an asset based solution, even though third parties exist that can fully document and monitor the transaction and take on at least some of the risk. Further, the potential market size of this opportunity is significant, involving start-ups, companies that have sputtered during the downturn, and others that are willing to pledge assets to obtain expansion capital. In particular, community banks should look at this financing tool as a way to further serve local companies.
– Merchant cash advance – involves the sale of a future credit card receivable in order to obtain immediate cash based on a percentage of the future sales.
Both of these products, and others, expand a bank’s capabilities and can differentiate a bank with its customers. Doing so may require working with people outside the bank, but, in our view, that also is a good thing.
Concluding thought.
Banks need to go where the customers are rather than expecting a return to the “good old days”. The good old days have been replaced by the “new normal” during which asset growth opportunities need to be pursued with greater persistence and creativity.