Ongoing Monitoring with Annual Reviews and Covenants

By Nick Reynolds, Vice President/Credit Services Manager of CU Business Group, LLC

The risks associated with business lending differ significantly from those associated with traditional consumer lending.  While consumer information is still an important part of knowing your member, the types of risks associated with commercial loans tend to be more varied, and wider in scope.  This article is one in a series to help credit unions more clearly understand some of the unique risks of business lending.

One area in which commercial loans differ from consumer loans is ongoing monitoring requirements.  Regulators expect you to maintain an ongoing understanding of your borrower’s current financial and business conditions.  This can be a challenge if your portfolio consists primarily of smaller-dollar transactions, but at the very least you should have a program in place to monitor the financial condition of your largest business relationships.

At a minimum, an annual or periodic review is required.  These reviews can be tiered, based on dollar amount, to match the appropriate level of analysis with risk.  Lower tiers should consist of an annual review memo with a review of payment history, fresh credit reports, and updated risk rating.  Higher tiers should consist of a site visit, cash flow analysis, and collateral assessment with a complete package of updated financial information from both the business and all guarantors.  After careful analysis of the borrower’s financial condition, you must decide if the risk rating should remain unchanged.

If your borrower’s financial condition has remained stable or improved, all the better.  But this is not an academic exercise.  If the financial condition of the borrower has worsened, you need to consider how to proceed.  Usually, at a minimum, you need to have a heart to heart conversation with your borrower to determine if they share your concerns.  Ideally they do, and have a plan for improvement.  If not, you should offer the benefit of your counsel, and take care to ensure they understand your credit union’s expectations.

One common way to implement actionable performance standards is through the use of covenants.  For example, a borrower with a history of distributing too much income to the owners might benefit from a minimum debt service coverage covenant.  It is important to recognize the borrower can’t meet what he doesn’t understand, so all covenants should be clearly documented and discussed at loan inception.

Covenants are a valuable tool for identifying issues that have a detrimental effect on your borrower’s financial condition.  But a covenant won’t make a bad loan good, and it is unlikely you can change borrower behavior with a covenant.  If the business has always operated at a debt service coverage ratio of 1.0, placing a covenant of 1.25 in the loan agreement is unlikely to change that.  Similarly, if you require the business to maintain a certain level of working capital on hand, but they have never met it historically, the likelihood is slim that they will meet it going forward.  Don’t set you and your borrower up to fail; be sure your covenants are realistic and achievable.

No matter how carefully you plan, at some point a borrower will violate a covenant. When that happens, you need to determine if the violation is one that jeopardizes repayment and requires action, or if it calls for an exception.  The careful use of waivers is an important but often overlooked aspect of covenant management, because you will rarely call a loan based on a single covenant violation.  Unless you waive it properly however, you will lose the ability to use it at all.  Whether the violation pertains to a ‘due on sale’ clause in your deed of trust, or to a clause in the note restricting the borrower from transferring ownership of the business, or to a straightforward financial covenant, the waiver process is generally the same. The waiver document must specify the nature of the violation, the time period over which it occurred, and that future rights are retained.  For example, if you become aware that your borrower transferred the subject property into a trust (in violation of the due on sale clause) and you don’t waive or enforce the clause, you will lose the right to enforce that covenant in the future.  If your borrower were to sell the property at a future date, they could reasonably invoke the defense that they transferred the property once before and you didn’t enforce the covenant, signaling implicit acceptance of their actions.

One of the principal differences between consumer and commercial lending is the higher standard required for monitoring the ongoing condition and performance of your borrowers.  While this is a burden, it is also an opportunity to serve your member, and may open the door to growing the relationship in the future.

CU Business Group Welcomes Dexter De Mesa as VP of Strategic Initiatives

Business services CUSO CU Business Group, LLC, recently welcomed Dexter De Mesa as its new Vice President of Strategic Initiatives.

De Mesa has a 25-year banking and commercial lending background and has held several executive level positions at credit unions throughout his career.

Prior to joining CUBG, De Mesa served as VP of Residential and Commercial Lending for SCE Federal Credit Union, where he oversaw commercial and mortgage operations. He also served as VP of Commercial Lending for Credit Union of Southern California,
where he led the creation and administration of a successful commercial lending program.

De Mesa has experience in originating and servicing all types of business loans including commercial real estate, lines of credit, and term loans. He is also a founder of the MBL Peer Forum, a regional networking organization comprised of commercial lending executives in Southern California.

In his role as Vice President of Strategic Initiatives, De Mesa will oversee CUBG’s participations area and loan sourcing program and the research and development of new products and services, as well as other special projects.

CU Business Group, LLC, provides a wide array of business lending, deposit and consulting services to credit unions nationwide. CU Business Group provides products and technical expertise to credit unions with advanced business programs, and all the basics for those just starting out. Based in Portland, Oregon, with offices in the West, Southwest and Eastern U.S., CU Business Group has a staff of 40 professionals and is the largest business services CUSO in the industry, serving 590 credit unions in 48 states.

Image of a contractor with a hard hat and holding plans outside and walking towards a residental property

Business Lending to Contractors

By Nick Reynolds, Vice President/Credit Services Manager of CU Business Group, LLC

The risks associated with business lending differ significantly from those associated with traditional consumer lending. While consumer information is still an important part of knowing your member, the types of risks associated with commercial loans tend to be more varied and wider in scope. This article is one in a series to help credit unions more clearly understand some of the unique risks of business lending.

Lending to contractors can present some unique challenges. Contractors are often desirable members that carry large-balance deposits and loans, are a critical catalyst for community revitalization, and can be a good source of referrals. Additionally, the residential and commercial construction industries have rebounded strongly from the late 2000s recession. However as borrowers, contractors come burdened with certain risks, and it pays to be sure you understand these risks prior to getting in too deep.

Value for Construction Put In Place, Source: U.S. Census Bureau

For the purposes of this discussion, we refer primarily to general contractors that do major projects, as opposed to trade contractors. Generally speaking, you can analyze trade contractors such as plumbers and drywall installers just like regular operating companies. However, contractors that use progress billings, account for their work on a percentage of completion method, and employ a bonding company, present much different risks.

Progress billings, whereby a contractor’s customer agrees to pay in installments as the work is completed, are common in the industry. However, be aware that such billings do not count as receivables on the balance sheet. Nor are they legally enforceable under a security agreement and UCC filing. From a practical standpoint, progress billings may not be collectible either, because if the job isn’t completed or is done incorrectly, the contractor won’t be paid.

The percentage of completion method of accounting is useful in estimating the borrower’s income, and a detailed work in process schedule should be obtained from any contractor you lend to, along with other standard financial information. The calculation of income is typically based on an amount of costs spent versus costs incurred ratio. For instance, if the contractor has spent 90% of the cost of a project, it is considered 90% complete, and you can recognize 90% of the anticipated income. But note that this doesn’t consider retentions that may not be paid for months, or at all, cost overruns, or other variances in income. Tracking the percentage of completion is valuable in understanding your member’s current financial condition, but an in-depth knowledge of the borrower and of the projects they are involved in is fundamental to understanding the risk. For example, who is providing the funding for your member’s construction project? It is not unheard of for a general contractor to begin a project, issue progress billings, and then not get paid because the customer didn’t have their financing in place. This is also a good reason not to provide lines of credit to a contractor. If they build for someone with construction financing, they shouldn’t require use of a working capital line. On the flip side, if the contractor offers financing to her customers, as the lender you should only finance one project at a time, giving yourself the opportunity to review each project on its merits.

Bonding presents its own issues. If your member can’t complete a project, the bonding company steps into their shoes. While the bonding company is generally in a subordinated lien position to your credit union, the practical effect is that the bonding company controls the process and determines who will get paid and when. You can be sure they won’t pay you before they reimburse themselves.

One of the more formidable risks common to all contractors is how much of their success relies on the individuals in their operation that are responsible for the bidding process. Most contractors are fairly adept at estimating project costs. But it only takes one missed estimate on a bid to potentially create a huge cost overrun. This may be the single most likely area for a contractor to create a big problem, and there is little you can do to prevent it. The best way to deal with this is to be sure your borrower has a significant amount of equity in the business to help them weather any single adverse event, and to discourage them from taking on projects with which they don’t have much experience.


What is Holding Back the Development of Comprehensive Business Services in US Credit Unions?

By Adam Szymanski and Donnie Maclurcan

Adam is a researcher at the Post Growth Institute. Donnie is a co-founder of the Post Growth Institute and an Affiliate Professor of Social Science at Southern Oregon University.

The institute behind this research is seeking a small amount of funding to enable the next stage of this study. They are also looking for credit union employees interested in completing a short survey and/or being interviewed about commercial capabilities. The researchers can be contacted at info@postgrowth.org.

Abstract

The credit union movement has experienced rapid growth across the United States in recent years. After the financial crisis of 2007-2008, US credit unions emerged more resolutely as trusted financial partners, able to maintain lending during the credit crunch and offering better loan and deposit rates, greater investment security and superior customer service. Credit unions are known for their focus on consumer banking. Yet this has obscured their changing relationship with businesses.


This paper seeks to discover the state of US credit union capabilities with respect to business banking services. After creating a classification for the level of US credit union business banking capabilities, we conducted informal, semi-structured interviews with a small sample of key stakeholders from the US credit union industry in order to provide insights into the nature of existing US credit union business banking capabilities.


Since US credit unions have been shown to provide direct economic benefits from consumer banking, along with a positive track record for small businesses, we are interested in credit unions’ potential to serve larger businesses beyond the provision of loans. Given that businesses have higher average deposits than consumers, there is potential for shifting significant resources from banks to credit unions.


Our findings suggest that while many US credit unions offer Basic Business Services, and some US credit unions offer Semi-comprehensive Business Services, no US credit union offers Comprehensive Business Services. We discovered three main factors holding back the development of these commercial capabilities: mission constraints; lack of apparent business demand; and lack of a strong business case according to a cost-benefit risk analysis. These factors appear to reinforce each other in a vicious cycle.


However, these factors may also present points of leverage for those seeking to expand business service capabilities within the US credit union system. For example, if weak business demand stems from an absence of targeted marketing to the private sector, a campaign to document pledged allegiance could reverse this phenomena. Indeed, we see strategic interventions at one of the three points offering the ability to shift the system from a vicious cycle to a virtuous one.

Szymanski, Adam and Maclurcan, Donnie, What Is Holding Back the Development of Comprehensive Businesses Services in US Credit Unions? (October 18, 2018). Available at SSRN: https://ssrn.com/abstract=3269580

CUBG Staff Support Soles4Souls Nonprofit

In a month-long fundraising mission, CUBG staff came together to support Soles4Soles, a non-profit that creates sustainable jobs and provides relief through the distribution of shoes and clothing around the world.

Staff collected 88 pairs of shoes and $250 to donate to Soles4Soles in just one month.

Who is Soles4Souls?

Soles4Souls is an international non-profit social enterprise based in Nashville, TN. Since 2006, Soles4Souls has distributed more than 30 million pairs of new and used shoes in 127 countries around the globe.

Their mission is to create sustainable jobs and provide relief through the distribution of shoes and clothing.

Why Shoes?

767 million around the world live in extreme poverty, less than $1.90 per day. 385 million are children.

Many don’t have access to sustainable employment to provide a steady source of income.

As a result, many don’t have the ability to provide basic necessities such as shoes and clothing for themselves or their family.

Their Approach to Wearing Out Poverty

  • Protect the environment – repurpose new and gently-worn shoes and clothing otherwise destined for landfills.
  • Create economic opportunities – utilize product to help entrepreneurs in emerging nations create and sustain small businesses to generate sustainable income.
  • Serve those in need – distribute new shoes and clothing to those in need and in times of disaster around the world.

Consistency and Oversight Critical in Financial Spreading

By Nick Reynolds, Vice President/Credit Services Manager of CU Business Group, LLC

The use of spreadsheets is standard practice in the analysis of any business loan.  Spreadsheets allow for the presentation of financial information in a consistent, standardized way within your credit union, so that all persons associated with the approval and review of loans are on the same page.  In addition, the use of spreadsheets is fundamental to a full and complete analysis of your borrowers, since they provide uniform treatment of ratios, as well as a consistent presentation among years for an individual borrower.  This year to year presentation is imperative for tracking all developing trends and changes in business conditions.

Today, there are a number of automated spreading tools available through cloud-based end-to-end commercial loan origination systems. Several of these tools are excellent, and provide a level of consistency and efficiency that is missing from traditional, manual spreadsheets. However, regardless of which tools are used it is critical that personnel have a solid understanding of the process.

Often, business lending shops will assign the spreading or credit analysis function to the newer members of the team, and as such it is valuable as a training tool.  But because spreading represents the foundation of the entire analysis, it is important to get it right.  This does not necessarily mean that figures from the tax returns should be transferred directly into the same line on the spreadsheet every time.  It should not be simply a mechanical process done by rote.  Spreading should utilize the same thoughtful input as underwriting.

Take for example, so-called “unusual items” on the borrower’s income statement, which may include items such as a large distribution or the gain on sale of an asset.  Such items are typically non-recurring, and the analysis should take that into account.  The best way to do that is to adjust it in the base spreadsheet, so that it will automatically translate to all down-process derivative spreadsheets and calculations.  But to do this, the entry-level spreading analyst must be on the same wavelength as your underwriting staff, which means the analyst needs to think like an underwriter.

Similarly, consistency is the hallmark of a good spread.  Experienced underwriters would rather see a statement spread incorrectly but consistently than correctly but inconsistently.  Changes in the analysis of a borrower that are due solely to the inconsistent application of varying spreading methodologies are not acceptable.  For example, examiners look askance if a relationship is downgraded simply because this year a “Due from Related Party” account was categorized correctly as an intangible asset, whereas it was incorrectly categorized in prior years. For all adjustments, the analyst needs to decide if leaving the spread incorrect is not material to the analysis, or if it needs to be re-categorized because it has a significant impact on the analysis.

The proper spreading of financial statements is a learned skill that takes time and experience to master. However, reality dictates that most credit unions have their spreads done by newer, less experienced analysts.  Because of this, it is critical to employ regular, engaged oversight of the spreading function, to ensure that this critical role is being performed in a consistent and high-quality manner.


Close-up of a dial showing high risk

Managing Risk After the Business Loan is Made

By Larry Middleman, President/CEO, CU Business Group, LLC

The business loan documents are signed and the funds distributed. That means your job is done, right?

Wrong. Due diligence and risk management are crucial steps after the business loan is made. Proper risk monitoring over the life of the loan is essential to identifying potential problems before they occur and early detection is the best way to fend off problems before they become big issues. 

Effective risk management practices also allow for frequent ‘touches’ of the loan in an efficient and cost-effective manner.  The days of simply doing an annual review on a business loan are long past.  As the late-2000s financial crisis amply demonstrated, conditions can change rapidly.

A Scaled Approach

In our work with credit unions across the country, we see many examples of excellent business lending risk management practices.  We also see credit unions where risk monitoring is non-existent.  In recent years, regulators have stepped up their oversight in this area, so be prepared for a rigorous review of your risk management practices in your next exam.

My view is that monitoring activities should scale depending on the general riskiness of the loan.  Important factors include the dollar amount of the loan, the type of loan, and the borrower’s industry.  Higher risk loans include lines of credit secured by accounts receivable or inventory.  Certain industries, such as retail and hospitality, often carry higher than average risk.

Many credit unions take an all-or-nothing approach to risk monitoring, e.g. “we only monitor loans over $250,000”.  While this attempts to balance monitoring efforts with the associated cost, in most cases a more thorough approach is warranted. 

I believe the right framework for credit unions is to adopt a risk management system for their business lending portfolio.  This holistic view encompasses all the key elements of risk monitoring, both on an individual loan basis and on the entire business loan portfolio.  Here are the fundamental steps in establishing a risk management system in business lending.

Tracking

Management must put a process or system in place for timely and effective follow-up.  A ‘tickler system’ is the best tool for setting key follow-up dates.  A typical follow-up activity would be sending a letter to the borrower requesting updated insurance records.  The trick is to re-set another tickler for two weeks later to ensure the insurance information has been received.  Simply sending the letter is not effective risk monitoring – actually receiving the information and analyzing it is true risk management.

Today, with the advent of cloud-based loan operation systems, tracking and follow-up is easier than ever. Automated tickler alerts can be set up that will email a notification to the loan officer, or even directly to the borrower.

Analyzing the Borrower’s Financial Condition

The fundamental activity in risk monitoring is reviewing the borrower’s financial situation. This will identify changes in condition as compared to the original underwriting and subsequent reviews of the loan, a key to identifying potential problems before they arise. You may notice that a borrower has had a decrease in sales or unusually high expenses, and that is the time to talk with your borrower. 

Global Cash Flow Analysis

It is critical to understand your borrower’s other obligations.  Other projects or commitments that go bad may drag down the performance of your good loan.  This takes expertise and resources, but again – early detection and fast action are the best methods of warding off loan losses.

Monitoring Industry and Market Conditions

When dealing with commercial real estate, look at the market conditions for the property. Are rents in the area rising or declining?  What are the occupancy trends of comparable buildings?

Consider the macro view of your member’s business. Will industry-related government regulations affect the company? Will potential state or federal taxes increase the price of the firm’s product or service?

Stress Testing

Stress testing is a tried-and-true method of identifying the key areas to watch for during the life of the loan.  At what point would the debt coverage be less than sufficient to support your loan payments?  How low can the lease income or occupancy rate go before there are potential problems with the cash flow of the property?

Multiple Touches

Automated risk monitoring solutions exist which allow for cost-effective loan monitoring between annual reviews.  We recommend at least two ‘touches’ of the loan in addition to the in-depth annual review.  These touches might identify certain situations, such as: Has the borrower’s or guarantor’s credit score recently decreased?  Are there any environmental issues with a property adjacent or near to your collateral?

Monitoring the Overall Portfolio

Credit unions must also step back and view the forest (the business loan portfolio) and not just the trees (the loans).  Does your portfolio have excessive concentrations in one loan type or industry?  What is the weighted-average risk rating of your portfolio?  What is your exposure relative to the credit union’s net worth?  Management must take the macro view to complement individual loan monitoring.

Reporting

I see it all the time…management believes the right things are being done, but they really don’t know – and sometimes they only find out when it is too late.  Proper management and board oversight is only accomplished with thorough and complete reporting from the business lending area of the credit union.  An effective risk management system includes a continuous feedback loop to keep everyone apprised of both the positive and negative aspects of the business loan portfolio.

As with individual loan tracking, systems exist today that take much of the manual effort out of portfolio monitoring and management reporting. Operational managers as well as senior executives and board members can have real-time access to detailed, easy-to-read dashboard reporting. Such reports can display information as varied as industry concentrations, portfolio profitability, and even average time-to-close.

I once heard a gem of wisdom that rings true: “The best way to make money in commercial lending is not to lose money.”  Implementing a risk management system will dramatically increase your odds of not losing money and being successful in business lending.

Larry Middleman is the President/CEO of CU Business Group, LLC, the largest business services CUSO in the industry, serving more than 580 credit unions in 47 states.  He can be reached at 866-484-2876 or lmiddleman@cubg.org.

Remote Deposit Capture for Business – A Must-Offer

By Larry Middleman, President/CEO of CU Business Group, LLC

Adoption of remote deposit capture (RDC) has come a long way in the past few years. Over that time, the mobile banking revolution has fully taken hold, with smartphones becoming virtual extensions of consumers’ identities. As part of that revolution, mobile RDC (mRDC) became mainstream, and it is now a given that financial institutions offer the service to their members/customers.

Many financial institutions recognize the urgency of this task.  According to Celent’s 2017 report, State of Remote Deposit Capture: The Final Stretch, more than 2,600 U.S. financial institutions went live with mRDC in the last two years.

Isn’t it time for your credit union to offer this critical service as well?

Why Must You Offer RDC?

Saves Time and Money. JPMorgan Chase, in announcing the closing of 5% of its retail branches in 2015, claimed that it realizes a 95% cost savings on every check deposited remotely, versus one processed by a branch teller. Your credit union may not realize such dramatic savings, but it is indisputable that the costs in terms of time, payroll, and branch overhead are significantly reduced when check processing is pushed closer to the end-user.

Your member benefits as well. Time-strapped business owners cannot afford to leave their operations for even a moment to drive to the credit union branch. With RDC, check deposits take far less time and effort, and can be done at the member’s convenience, rather than during “banking hours”. Businesses are free to make deposits more quickly and frequently, improving check clearing times and cash flow.

RDC also benefits the environment by minimizing wasteful trips to the credit union branch, saving gas, and reducing harmful emissions.

Eliminates Geographic Barriers. When competing against much larger banking institutions with branches and ATMs on every corner, electronic services like RDC are ways to even the playing field. Thanks to today’s internet-based technologies, any credit union business member can enjoy the same convenient and speedy account access as with Bank of America. With RDC and other remote banking channels, geography and location are no longer the critical service differentiators they once were.

An Opportunity to Earn Additional Fee Income. Although free mobile check deposit has become common-place among consumers, the additional features that business clients require means that there are still opportunities to charge for services.

Yet high fees may be discouraging commercial clients from adopting feature-rich desktop RDC services. It is important for credit unions to keep the cost factor in mind, particularly as they target down-market into the huge and potentially lucrative SMB sector.

According to Bob Meara, as senior analyst with Celent and the report author, “A low cost and easy to sell mRDC solution appropriate for SMBs is the missing ingredient.”

By offering mRDC, credit unions build stronger, “stickier”, and ultimately more profitable relationships with their business members.

Provides Access to Reams of Member Data. One the most interesting developments in mobile RDC technology over the past few years is its built-in data collection capabilities. For credit unions, the opportunity to mine valuable member data is every bit as important as the payment or check deposit itself.

Transactional data contains a treasure trove of information on your member’s behavior, useful both in managing fraud risk as well as highlighting opportunities to provide better service and address your member’s specific business needs.

What Are the Key Considerations for Rolling Out RDC?

Mobile vs. Scanner: It used to be a simple equation. Mobile device check deposit technology was originally designed strictly for consumers or the simplest, low-transaction business use, as one-at-a-time check scanning is too time-consuming and unwieldy for purposes of depositing a heavy volume of checks.

However, mobile RDC solutions that meet the needs of commercial and small business members much more effectively have recently been introduced. New features allow businesses to submit multiple checks in a single batch, and can even support multiple users working remotely in the field.

Still, mobile RDC is not the right choice for every business. According to industry experts, traditional desktop scanners are still much more effective for high check volumes; say more than 5 or 10 checks at a time. High-volume scanners save business members significant time and a lot of aggravation over snapping one-at-a-time photos on a mobile device.

Risk Management: The risk of fraud is one key reason why many financial institutions have waited to roll out an RDC service offering. The threat is real, but recently reported trends have belied many common perceptions of risk.

According to RemoteDepositCapture.com’s 2016 State of the Industry report, banks and credit unions surveyed suffer a duplicate check loss rate of just 0.0104% on mobile check deposits. The study also stated that 76% of financial institutions surveyed reported no direct mobile RDC losses, and 92% believe that the benefits of mRDC outweigh the risks and costs of the program.

“RDC solutions, when paired with sound risk management policies, actually deliver more data and protections than traditional, paper-based check solutions,” says John Leekley, founder of RemoteDepositCapture.com.

With built-in tools such as geolocation and biometric scanners, smart phones are giving banks and credit unions the ability to identify unusual geographic and psychographic patterns, and prevent fraudulent transactions before they occur. For instance, your credit union’s fraud detection department may recognize a mobile device in California depositing a check from a New York-based bank to the account of a member based in Virginia. You now have the opportunity to contact your member to confirm that the transaction is legitimate. Old-school mail deposits provide no way to spot these types of suspicious transactions until it’s too late.

Access to Tech Support and Staff Training: Having technical support available is imperative to a successful RDC program. Your business members will undoubtedly have questions and problems will arise. It is important to consider up front whether the credit union or the vendor will provide first-line support. Even if the credit union is the first line of defense, it is a big learning curve for staff, so ensure that you have adequate vendor support and training from the get-go.

Such training should go beyond the member contact center and technical areas, however. Credit union branch and business development personnel are the keys to effectively pitching the benefits of RDC to current and prospective business members. Ask yourself these questions before rolling out your RDC service: Who will do the training? Which credit union department will maintain ownership of the service? How does RDC fit into your credit union’s strategic goals and marketing plan?

Gone are the days where RDC is a “nice to have” product. Member expectations have developed to the point where every financial institution must offer at least one, if not several versions of the platform to serve their various target markets. Don’t get left behind in the mobile RDC revolution!

A person notating inspection on a tablet in the foreground. Two people in safety gear visually inspecting and pointing to something out of the image in the background.

Guarding Against Common Appraisal Pitfalls

by Nick Reynolds, VP/Credit Services Manager

The risks associated with business lending differ significantly from those associated with traditional consumer lending.  While consumer information is still an important part of knowing your member, the types of risks associated with commercial loans tend to be more varied and wider in scope.  This article is one in a series to help credit unions more clearly understand some of the unique risks of business lending.

Appraisals are an important piece of your business lending program for several reasons.  To begin with, they are required under current regulations. Appraisals must meet certain conditions and provide a value that is completely independent.  Beyond the compliance aspect, appraisals help to protect both you and your member, and are a core factor in assessing what is typically a major item of collateral.

There are a few things, however, that can create problems in an appraisal.  One of the most common is the determination of business value.  In its guidance, the National Credit Union Administration (NCUA) prohibits the use of a so-called “going concern” business value in appraisals.

In practice, appraisers often have a difficult time separating going concern value from the “pure” real estate value.  This is particularly true in single-use facilities, like bowling alleys, car washes, gas stations and convenience stores, hotels, water parks, golf courses, and movie theaters.  Many appraisers like to include going concern business value, as it makes their overall analysis easier.  On such single-use properties, you might want to consider including a specific clause in your engagement letter requiring the exclusion of going concern value.

Beyond going concern value, you can consider equipment and personal property values in your collateral pool, but should do so with thoughtful consideration.  NCUA guidance requires, at least, that those values are separated in the appraisal so you can make an accurate determination of their value as collateral.  In cases where the personal property is a significant portion of the value, you may want to lend on those separately, where you can use a shorter amortization to allow for the shorter life of the asset.  A general principle of lending is to match the life of the loan with the life of the asset, and this detail in the appraisal will make that possible.

The primary goal of the appraisal is to provide an “as is” value, and this is where your underwriting should be focused.  You may consider prospective values, projections, and market rates, but when it comes time to fund your deal, your collateral is worth only what the appraiser has valued it at today.  The amount of value you recognize for all of those future events is based on your knowledge of your borrower, and your confidence they can execute their plan.

There are a number of ways to determine value.  The three most common methods are the cost approach, the sales comparison approach, and the income approach.  Some lenders use a discounted cash flow approach, but this method makes a lot of forward-looking assumptions.  If your borrower has long-term leases with escalation clauses, the discounted cash flow approach may be justifiable.  However, be aware that this is the most common method of determining business value, and as we discussed, that is not an element you are allowed to recognize as collateral value.

A complete and well-supported opinion of value is a critical piece of your underwriting process. But do not rely on it solely at the expense of your own judgement and knowledge of market conditions. The appraisal contains many pieces of valuable information, but your knowledge of your local business and real estate markets is your biggest safeguard against overvaluing your collateral.

Deepening Business Relationships Through Payments

By Melissa Giddens, CTP, AAP NCP, SVP, Consulting Business Leader, WesPay Advisors

Most businesses have a need for financial services above and beyond a loan and basic deposit account. Whether the business’ need is online and mobile banking or extends to ACH or wire payment origination services, businesses of all sizes are placing greater importance on the ability to maximize payables and receivables, mitigate the risk of fraud, and leverage information to make cash flow decisions. Credit unions need to have the resources and skills required to help their business members thrive.

Offering payment solutions can help meet the needs of business members, but also generate non-interest income for a credit union. Businesses pay for value perceived, therefore charging a fair and competitive price for payment services can help a credit union serve its field of membership and cover the costs for providing the services. Meeting the needs of businesses from a payments perspective can contribute toward retaining existing relationships, winning new business and creating a ‘stickiness factor’ that lends itself toward long-term, satisfied business members. It’s a win-win situation for a credit union.

Below are a few tips to keep in mind when working with businesses:

  • Lead with a conversation. Make it your mission to learn as much as you can about a business prospect before discussing your product offering. Talk to them about their business and make the focus all about them. Ask them how their current account and service structure is working, what efficiencies would benefit them, if their clients are requesting new payment options, etc. Taking the time to understand what’s working and what needs to be improved upon with their current provider can provide invaluable insight into how your credit union could meet those needs before ever mentioning a single product.
  • Drill into their payments needs. Get the prospect talking. Ask a wealth of questions to understand how they are utilizing payments in their business. How are they managing payroll, vendor payments, employee reimbursements, etc.? Conversely, how are they being paid from their clients? And, keep drilling down. If they receive a healthy number of checks, how are they depositing those checks into their account? Are they going into a branch, using a courier, leveraging remote deposit, etc.? And, are they receiving the information they need to reconcile transactions, manage their cash flow, etc.? What type of reporting do they need? Are they concerned about fraud? The more you understand a business prospect’s payments needs, the better positioned you’ll be when delivering a tailored proposal and ultimately, servicing the relationship.
  • Become a trusted advisor. Relationships with businesses extend beyond the services a credit union provides. Continually look for ways to add value for your member. Share an article on fraud prevention that may be meaningful for them along with a personalized note, send industry updates that pertain to past conversations you’ve had with them, etc. Let them know you’re thinking of them and keeping them in mind as you come across new information or resources. Create an environment where they look to you as their financial resource.
  • Do your homework. Research your prospect to understand their line of business, key company leadership, new initiatives they’re tackling, recent awards they’ve won, etc. and comment on what you’ve learned during meetings. Congratulate them on a new product they’ve launched or an industry award they’ve earned. Demonstrate that you’re prepared and that you’ve done your research. Prospects can tell when a potential provider shows up unprepared, so don’t give them a reason to question whether or not your credit union is the right fit for them.
  • Master the little things. Follow up timely. Do what you say you’re going to do. Send thank you notes or emails. Write down important takeaways you hear during the discussion, such as birthdays, a dream vacation they’re about to take, etc., so you can send them an annual birthday card or ask them how their trip went during your next conversation. Servicing businesses starts with building a relationship with the people you’re interacting with, so going the extra mile to demonstrate you were listening goes a long way toward building trust.

Working with businesses is an exciting opportunity for a credit union, as a business’ needs are continually evolving. Businesses look for a true financial partner to guide them through the changing financial landscape and how new products coming to market, regulatory changes, economic considerations, etc. may impact their organizations. When it comes to payments, selling solutions to businesses provides another opportunity for credit unions to shine in servicing the needs of its communities.

Melissa Giddens is the SVP, Consulting Business Leader for WesPay Advisors, a consultancy helping organizations advance their development and deployment of electronic payments. Prior to joining WesPay Advisors, Melissa worked with businesses for over 21 years to help build optimal structures for managing payables and receivables, mitigating the risk of fraud and maximizing cash flow. In 2016, she won the Frank E. Zima Payments Advocacy Award and has won numerous sales awards throughout her career. Melissa earned her Master of Business Administration from Green Mountain College. She holds the Certified Treasury Professional (CTP), Accredited ACH Professional (AAP) and National Check Professional (NCP) designations. Contact Melissa at mgiddens@wespayadvisors.com or 415-373-1180.