Don't Sell Branches Short-small

Selling commercial services isn’t easy.

Business loans and deposits are more complex and nuanced than common consumer financial products like auto loans, savings accounts, and residential mortgages. Credit unions also have a lot of competition for commercial clients—from community banks, national banks, and online marketplace lenders.

But credit unions have a secret weapon that many of those competitors—especially non-bank lenders—don’t have: a network of branches with deep ties to the community.

Yet, many credit unions don’t take advantage of this stealth superpower. Often, the central office controls every aspect of the business services and commercial lending process, from fielding business member calls to conducting site visits. They underwrite, approve, and book the loans. They cross-sell deposits and related services.

Meanwhile, when a business member does step foot in a branch and asks a credit union employee a question about their commercial loan, they are often greeted with a frozen stare.

Why? Because branch staff don’t know how to “talk the talk” in commercial services.

Commercial services are a great way for credit unions to grow loan volume, increase membership, and reach deeper into their communities. Don’t discount the vital role your branches can play in this process.

Unleash Your Branches as Your Commercial Services Sales Team

For many of your members, their local branch IS your credit union.

Your members are used to turning to the branch staff for answers – these are the people they know well and interact with on a weekly basis. They generally don’t have the same close relationship with the folks back at the main office.

At some credit unions, branch managers may serve as the face of the franchise. They attend the Chamber of Commerce breakfasts, ribbon cuttings for new businesses, and the golf outings. They are out and about on “Main Street” in the communities you serve.

In addition, your most experienced salespeople are often out in the branches. Your branch managers, member service representatives, and tellers are skilled at assessing members’ diverse needs and matching them up with the right solutions.

Armed with these structural advantages and the right tools and training, your branches are primed to expand your commercial program and deepen your credit union’s relationship with businesses in the communities you serve.

How to Supercharge Your Branch for Commercial Sales

To set your branches up for success in selling commercial services, begin by coaching them on these 5 key process steps:

  1. Keep Your Eyes Peeled: First, your branch staff should constantly be on the lookout for new opportunities. Whether working the teller line or in an office, they should listen for clues that may tip off a hidden need. Did the member mention they are starting a new business? Buying a franchise? Applying for an SBA loan? Are they looking to expand their current business? Hiring additional employees? Planning to purchase a new facility? All of these are good conversation starters to help your team engage in a deeper discussion with the member.
  2. Take Good Notes: Encourage your branch staff to take copious notes when speaking with your business members. This isn’t rude—it’s an important technique to ensure they capture all the details. The commercial loan cycle has a longer timeline than those of most consumer or retail products. Whereas a car loan can be approved and funded in a single day, a typical commercial real estate loan may take months to be underwritten, approved, and closed. It’s very easy to forget the nitty gritty details of the borrower’s situation unless it is documented fully.
  3. Match Product to Need: The branch rep should ask a lot of questions during the initial interview, and resist offering solutions until they have a good understanding of the member’s unique needs. One of the big advantages of commercial lending is that regulations are much looser than for consumer lending, so lenders don’t have to provide compliance disclosures, like HMDA or TILA/RESPA, or commit to an APR at the time of application. Your team can take advantage of this flexibility to explore how they can best help the member while remaining in a strong competitive position.
  4. Gather the Loan Package: If a commercial loan opportunity is uncovered in that initial meeting, the branch rep should provide the member with the appropriate application forms and checklists. As the borrower’s primary point of contact, the branch representative should also offer their contact information before the member leaves the branch.
    Once the branch rep has gathered the loan application, their role doesn’t end there. They should follow the process through to completion, acting as the liaison between the member and the commercial services department, and ensuring the process stays on track within the promised timeframes. They should be available to ensure all of the questions the business has get answered and a timely decision is communicated. Encourage your branch staff to attend the loan closing, to help celebrate the moment and cement the relationship!
  5. Keep the Relationship Alive: Post-closing, the most successful branch salespeople maintain regular contact with their business members by phone or visits to their place of business. When the member comes in the branch, staff should greet them with a warm smile, and ask how the business is doing and whether they have any emerging needs or challenges. They should also recognize opportunities to cross-sell other products and services, such as analyzed checking accounts, remote deposit capture, or a business credit card for purchasing supplies.
    Above all, branch reps should always provide outstanding service, and position themselves as the business member’s “personal banker.”

Commercial products and services are undoubtably more complex and variable than retail banking. But the commercial side is not nearly as scary as many branch staff believe. Through investment in training, education and the right incentives, credit unions that have unleashed the power of their branch network have realized profound success in this vital and growing area of opportunity.

 


About the Author

Mike Mucilli, CU Business Group

Mike Mucilli,
SVP/Senior Business Services Officer

Mike has spent his entire career gaining expertise in banking, commercial lending and sales. He has underwritten all types of business loans. He also has extensive experience with SBA lending and served as a Director of Consumer and Home Equity Lending. He is a former instructor for the American Institute of Banking and has taught extensively throughout his banking and credit union career. Mike consults with credit unions in the eastern U.S. on all aspects of business services planning, program development, account pricing, and education.

Due to the coronavirus, credit unions and businesses have been forced to adapt and change the way they interact. Remaining nimble and proactive during these changing times will help your credit union solidify existing business relationships and attract new business members. By taking the following six steps…

In 2016, the NCUA revised commercial lending regulations to allow credit unions to set their own personal guaranty requirements.  While credit unions can now choose whether to waive personal guaranties altogether or obtain limited, partial, or pro rata guaranties, it’s important to remember why personal guaranty requirements were established in the first place.

Conceptually, there are very few good reasons to ever waive a personal guaranty.  As the lender, the only benefit you receive from a commercial loan is interest income.  The owners of the business or commercial property are positioned to benefit from the upside potential when the enterprise succeeds, or when the collateral property appreciates in value.  Since the upside benefit accrues to the ownership, they should accept the majority of the risk as well.  This is the nature of entrepreneurial risk.  The equity owners risk their capital to enjoy the profits.  The lender should not be responsible for the risk of entrepreneurial failure.

Additionally, you should consider exactly why the owners would ask a lender to forego the guaranty.  They are asking the credit union to invest its capital in the project, and they should have at least the same willingness to put their assets on the line.  Owners are required to invest just 20% equity into the project, and in exchange they should provide reassurance of the lender’s 80% commitment via the guaranty.  The question to ask the borrower is “Why should we invest if you don’t have this level of confidence in the project?”

These are just a few of the reasons why it makes sense to decline most requests for unguaranteed loans.  However, you will get requests like this from time to time, and you should be prepared to deal with them.

One way to approach such requests is to consider the lack of a guarantor as a significant weakness that needs to be mitigated.  This mitigation needs to be substantive, such as offering a smaller loan amount to lower the LTV on the collateral or requiring a larger down payment.  The guarantor may also provide additional collateral in lieu of a guaranty.  Covenants are good monitoring tools, but do not lower the actual risk of the deal.

There are several situations where it makes sense to pass on a request for the waiver of a guaranty.  Such scenarios include those situations where a guarantor has taken substantial distributions or loans from the borrower, or has demonstrated in any way that his personal well-being comes before that of the business.  A similar scenario is a request for a cash out refinance.  In this case, the owners would directly benefit from the loan, while concurrently transferring risk from the ownership to the lender. There is no way to justify a waiver of personal guarantees in that scenario.

Let’s also consider an owner-occupied real estate loan.  The operating company should always guarantee these types of transactions, in the form of a cross-corporate guaranty.  The risk rating and assessment of the credit should be based largely on the health of the operating company, as that is where repayment will come from.  This is another example where there is little justification for ever waiving a guaranty.

Unguaranteed credit facilities are usually the type of product offered by life insurance companies on very large real estate projects.  These “non-recourse” facilities are usually approved based on the professional, experienced management of the property, very low LTVs, and a significant cushion in debt service coverage.  This is very different from the types of requests most credit unions see as a matter of course. But you will on occasion receive requests to waive personal guaranties, and it is important to recognize when the best decision you can make is to decline the deal, or to structure it in a way that reduces the risk to a manageable level.

Preparing and analyzing the proforma cash flow for income producing commercial real estate is an important part of the underwriting process to determine the property’s projected ability to service debt. A basic NOI analysis of a commercial property includes gross rental income and operating expenses (e.g. property taxes, utilities, insurance), but prudent business loan underwriting practices suggest it should also include a vacancy factor, management fee, and replacement reserves. So why should you include these additional deductions in a CRE analysis, and can they be excluded if they have not been incurred in the past or are not expected going forward?

CUBG’s expert staff provided this tip in response to these questions and others we hear frequently from our clients.

Q: Why should a vacancy factor be included in the CRE Analysis?

A: Vacancy can be unavoidable, particularly in residential properties or other property types with short-term leases.  However, it can also be seen in properties with long-term leases due to a variety of business-specific or market factors.  Therefore, it is prudent to include a vacancy factor in the cash flow analysis to account for a potential loss of rental income associated with unoccupied unit(s), rent concessions, or non-payment.  Typical vacancy factors range from 3% to 10% of gross rental income and can be estimated from internal underwriting procedures, an appraisal, and/or other market data.  A vacancy factor will also be applied by an appraiser and a potential investor to stress the cash flow in order to determine the property’s income potential and ultimately its market value.

Q: Why should a management fee be included in the CRE Analysis?

A: A management fee is a recurring operating expense that should be accounted for in cash flow.  The fee is paid to a third-party management company who ensures rent is collected, tenant’s repair requests are handled, and much more.  The actual fee should be included in the NOI when the management agreement and/or cost is available.  However, in many cases, the fee is unknown at the time of underwriting and can be estimated based on market rates and/or internal underwriting procedures.  Management fees typically range from 4% to 5% of Effective Gross Income (EGI) and depend on property type; refer to CUBG’s recommendations below.

What if the borrower will self-manage the property and will not incur a fee from a third-party property management company?  It is still prudent to include a management fee as it is an industry standard expense that an appraiser or potential investor would include in a proforma and directly effects the property’s income and value.  Additionally, this considers the possibility that in the event of foreclosure the credit union would need to employ a property manager while the property is marketed for sale or liquidation.  The potential purchaser would also likely analyze the property’s cash flow with a management fee included.  Thus, it is important that the credit union analyze the property’s ability to support a potential management fee and continue to service the debt.

Q: Why should replacement reserves be included in the CRE Analysis?

A: Capital improvements are inevitable costs that investors must plan for as a property ages.  These expenditures are an important, and necessary, part of maintaining an attractive, fully occupied property that is free of deferred maintenance issues that may adversely affect the property’s market value over time.  Accordingly, it is prudent to include reserves in the cash flow analysis to ensure the property can support repairs without relying on additional outside capital injections, additional indebtedness, or guarantor support.  Replacement reserves should even be included when a property has a strong triple-net (NNN) lease(s) in place, as there are certain replacements that are typically still the responsibility of the property owner (e.g. structural repairs). Consistent with the other two deductions, an appraiser, and a potential investor alike, would consider replacement reserves in the calculation of the property’s NOI.  Replacement reserves vary based on property type; refer to CUBG’s recommendations below.

CUBG Recommendations and Example:

The examples below were developed by CUBG’s staff based on industry standard underwriting practices and an analysis of market appraisal standards.  An example of an office property proforma cash flow follows.

Replacement reserves recommendations chart

Example of NOI DSCR of a office property

Please contact info@cubg.org for any additional questions or clarifications on this topic.

Amortization and maturity are frequent terms heard in the financial industry. Both have important uses in business lending, but what is the difference?

CUBG’s expert staff provided this tip in response to a question we hear frequently from our clients.

Q:

What is the difference between amortization and maturity, and can these terms be used mutually?

A:

Although both terms revolve around the final payment of a loan, amortization and maturity have very distinct differences, and are not interchangeable terms.

What is amortization?

Amortization is an accounting technique used to periodically lower the book value of a loan (or other intangible asset) over a set period of time. Amortization is used in the process of paying off debt through regular principal and interest payments over time. A balloon payment consisting of the unpaid remaining balance of the principal and interest will be due at maturity.

What is maturity?

In finance, the maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal (and all remaining interest) is due to be paid in full.

Amortization vs. Maturity

Amortization is the schedule of loan payments, and the maturity is the date the loan term ends. The amortization period and maturity term can be the same, but sometimes the amortization is longer than the maturity. For example, the loan payment schedule (amortization) can be calculated over a 20 year period, but the loan term (maturity) ends after 15 years. At the end of the loan term, the remaining principal and interest will be due.

Federal Regulations

NCUA regulations set limits for loan maturities for federally chartered credit unions. Regulation §701.21(c)(4) states that the maturity of a loan to a member may not exceed 15 years. There are some exceptions to this regulation – see the full regulation for more details.

Loan Maturity and Loan Documents

For credit unions using CUBG for loan documentation – the loan maturity and amortization are important parts of the documentation request form.

Please contact info@cubg.org for any additional questions or clarifications on this topic.

From 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.

The “5 C’s of Credit” have long been a cornerstone of prudent business loan underwriting practices.  One of the 5 C’s is Capacity, which refers to a borrower’s ability to service its debt obligations from the cash flow of the business.  Capacity is most commonly measured by the Debt Service Coverage Ratio (DSCR).

In its simplest terms, DSCR is calculated by dividing the annual cash generated by the business by total annual loan payments.  For example, if the business generates $100,000 in cash for the year, and total debt payments are $80,000, the DSCR equals $100,000 divided by $80,000, or 1.25.

However, as is often the case, the devil is in the details.  Elements of both the numerator and denominator of the ratio are subject to interpretation.

In the most common methodology, cash generation is calculated by taking the borrower’s net income and adding back depreciation and amortization.  Typically, you should subtract any distributions made because they represent cash taken out of the business, and are thus not available to pay the debt.  Gains on sales, investment income or losses, and other unusual or one-time items should also be removed.  These adjustments help in determining a more accurate picture of the borrower’s ongoing cash flow.  Similarly, a loan should not be made based on just a single year of positive performance.  As a result of these factors, estimated annual income is often open to interpretation, and all assumptions should be explained clearly.

Calculation of the denominator of the DSCR is generally more straightforward, but does depend upon a full and complete understanding of the borrower’s debt obligations.  Underwriting is highly sensitive to changes in DSCR, so it is critical to obtain a debt schedule from the borrower.  If a debt schedule is not available, you will need to make some assumptions, and there are some areas where it is easy to misstep.  For instance, lines of credit are often misclassified as long term debt.  Another example is when a term loan is within a year of its balloon payment maturity.  The borrower may have every intention of renewing the loan, yet the entire balance coming due will show up as a current liability.

There are some other refinements to the DSCR that are worth mentioning.  You may be familiar with the accounting term EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.  If you use EBITDA in the numerator of the DSCR, you should be using the full amount of the loan payments‒both principal and interest, in the denominator.  Since the cash generated has the interest added back, it is then appropriate to compare that figure with the full loan payment obligation.  Another common approach is to use just net income plus depreciation and amortization in the numerator, and only the principal portion of the loan payments in the denominator.  This is a standard approach with larger borrowers that provide GAAP-standard audited financials including a line for Current Portion of Long Term Debt.

Lastly, it is important to consider major changes that will occur in the business as a result of the new loan.  For example, in the case of an operating company that is purchasing its first owner-occupied property, you should add back the historic rent payments to the numerator of the DSCR.  If the borrower is trading up to a more expensive property, simply add the difference between the prior mortgage payment and the new payment.  There may also be additional costs associated with the transaction, such as moving expenses, residual payments under a prior lease agreement, and for renovations or improvements to the new location.  It is important to have a conversation with your borrower to determine the nature of such expenses, and to ensure the business has sufficient liquidity to absorb them.

A full understanding and analysis of both recurring and non-recurring income and expense streams are critical to accurate business loan underwriting.  At the end of the day, you need a reliable methodology to assess your borrower’s ability to repay their debt obligations. DSCR is a tried-and-true technique that fits the bill.

Image of a magnifying glass over a commercial building

From Nick Reynolds, VP/Credit Services Manager

While appraisal reviews are a necessary step to ensure that the appraisal is accurate and compliant, they are also a critical component of the loan underwriting. Many of the findings that result from performing an appraisal review are key to include in the credit write-up and in making a decision on the loan.

For example, with an appraisal on a single family residential home in a subdivision, you could conceivably have hundreds of comparable properties that are from recent sales, are close by, and result in a high-level of confidence in the appraisal figure.

In the case of a unique property such as a large church in a rural location, the story is different. The comparable sales will be similar, likely also large churches in rural areas. However, there is little likelihood of recent local comparable sales. Comparables will probably be older, and won’t represent local demographics, traffic flow, employment, etc. While the appraiser may have concluded a reasonable value, there is a great deal more variability in possible values of the property. The underwriting must acknowledge the additional risk this variability in value represents, typically by lending at a lower advance rate.

Consider the residential property example above. If you know the value within +/-2%, you can use that value in your underwriting with confidence. In the church loan, you might only have confidence that the value is representative within +/-15%. As a result, it would be recommended that you limit your advance rate to the lower value, which would indicate 15% less than your usual advance rate of 80%.

Essentially, the appraisal review helps you answer this question: How confident am I in the valuation, and can I lend at 80%? This level of confidence will be different with every appraisal, and needs to be assessed as part of the underwriting process. Your appraisal review should indicate where this might be a significant issue.

Other questions the appraisal review can help with in underwriting – Is the term of the loan within the remaining economic life of the property? Are there other unique features of the property that increase the potential viability of the value? Are actual rents significantly different than market rents? All of these issues should be pointed out in an appraisal review, and are features of the appraisal that impact the underwriting, but are not typically pointed out as weaknesses by the appraiser.

Looking at the transaction from a credit perspective and commenting on features of an appraisal that may create credit or loan structure issues for credit unions is critical, and something CUBG consistently does in our appraisal reviews. CUBG also takes a conservative view of unique properties, taking into account the difficulties that can arise in working out a loan where those properties need to be liquidated or resold.

For additional information on CUBG’s appraisal review services, contact us at info@cubg.org.

Stacks of present donations on a office counter

At the end of each year, CUBG staff team up to support local charities in the spirit of the holiday season.

The 2019 holiday giving campaigns included a food drive to support SnowCap Community Charities and a giving tree to support Morrison Child & Family Services.

SnowCap Food Drive

SnowCap Community Charities is an organization that provides food, clothing, advocacy and other services to the poor.

Barrel full of food for a pantry donation

CUBG staff participated in a food drive to collect food, diapers, and baby formula to help SnowCap stock their food pantry before Thanksgiving. All together, the staff collected 344 pounds of food and $340 for a cash donation.

Morrison Child & Family Services Giving Tree

The mission of Morrison Child & Family Services is to help children, youth, and their families with mental health and substance use challenges while working to prevent them from developing in the first place.

Stacks of present donations on a office counter

CUBG staff adopted three families from Morrison and set up a giving tree to provide each family with presents for this holiday season.

The support from staff was overwhelming, and all together provided more than 70 presents for 12 members of three families.

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.  However, 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.

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.