The Case for Small Business Lending

But often, these lenders provide a poor customer experience along with higher borrowing rates and unfavorable terms.

This presents credit unions with an opportunity to expand their foothold in the small business lending market.

The good news is that credit unions know lending well, given their long history of offering consumer products like auto loans, personal loans, revolving credit lines and home equity loans. Better yet, credit unions are adept at identifying their members’ borrowing needs and providing outstanding service!

Although newer to the space, credit unions have also been rapidly growing their commercial loan portfolios over the past decade. In fact, since 2014, credit union commercial loan portfolios have ballooned by 217%, while community banks have seen their portfolios decline by 5%.

Despite this impressive growth, many small businesses don’t consider credit unions as their first choice for their financing needs. In fact, according to a 2021 Small Business survey conducted by the Federal Reserve, only 8% of business borrowers apply for credit with a credit union, compared with 79% who apply with a large or small bank.

To flip this script, credit unions should expand their commercial lending programs to include true small business lending, including C&I (commercial and industrial) loans.

C&I lending helps to diversify a business lending portfolio, mitigating potential risk. It’s also less transactional than commercial real estate (CRE) lending, making it a better vehicle for fostering long-term relationships, especially when used to attract a business’s deposit accounts.

But to do it right takes specialized expertise and a commitment of resources.

What Is C&I lending?

C&I loans are typically secured by business assets such as accounts receivable (A/R), inventory or equipment. They can also be granted on an unsecured basis for businesses with strong underlying financials.

This distinguishes them from CRE loans, which are mortgages secured by real property, and small asset secured loans and leases, which are secured by commercial equipment or vehicles.

C&I borrowers may range from startup businesses to established enterprises, and include businesses in industries like manufacturing, retail, wholesale and services that require significant capital for operations.

C&I loans may be structured as term loans or lines of credit, may have fixed or variable interest rates, and feature repayment terms ranging from a few months to several years.

Barriers to Offering C&I Loans

• Complex borrower needs: Small businesses have diverse and dynamic financing needs requiring customized loan structures and active monitoring. C&I loans are typically more complex than a straightforward CRE loan tied to a property or a small business loan secured by equipment or vehicles.
• Collateral and risk assessment: C&I loans are typically collateralized by working assets, which can be harder to value. In addition, the value of these assets often fluctuates widely due to seasonality and variability in business operation cycles.
• Credit expertise and underwriting: Because of their complex structures, underwriting C&I loans requires a detailed analysis of business financials, cash flow, industry-specific risks and management experience. It’s also important to understand seasonality factors and the unique business cycles of the borrower’s industry. Credit unions new to business lending may lack the expertise or specialized staff to perform this level of analysis effectively.
• Monitoring and management: Some C&I loans, especially those that utilize A/R or working assets as collateral, require a higher level of ongoing monitoring than the annual reviews typically required for CRE loans. Most require monthly or quarterly reviews that include a recalculation of the borrowing base.
  Business lending departments must have the back-office capacity and resources to manage this ongoing monitoring requirement, unless they choose to outsource the function to an experienced CUSO like CU Business Group.
• Competition from larger lenders: Larger banks and non-bank lenders dominate the C&I space due to their ability to offer larger credit lines, specialized financial products like cash management or trade finance services, and faster decisions supported by digitally enabled underwriting. Small lenders like credit unions struggle to compete due to fewer resources, lack of scale and limited product offerings.
• Regulatory pressures: C&I loans are subject to stricter regulatory scrutiny than CRE and small equipment loans because of their inherent risk and the difficulty of accurately valuing non-tangible collateral. Because credit unions are limited to how much of their lending can be allocated to the commercial portfolio, they often prioritize real estate loans because they are less resource intensive.
• Lack of technology support: Credit unions by and large have designed their commercial lending programs for the purpose of underwriting large, complex CRE loans. They try to force C&I lending into this structure, even though small business loans are closer in profile to consumer loans. The result is an overcomplicated, inefficient underwriting and decisioning process that is a drag on resources and diminishes the member experience. Credit unions should leverage today’s streamlined technology to handle these simple loan requests efficiently and expeditiously, reducing the impact on staff and providing the member with a smoother and more streamlined experience.

Capitalizing on the Business Lending Opportunity

To date, credit unions have overcomplicated small business lending, treating these requests on the same level as multi-million-dollar CRE loans. The primary repayment factor for a small dollar loan request is the creditworthiness of the business owner guaranteeing the loan. This same owner could walk into a branch and be approved for a consumer loan of the same amount and relative risk in a matter of minutes, but because the loan will be used for business purposes, the commercial lending department will run it through a process designed for large CRE loans. To be competitive, credit unions need to evolve their small business lending processes to align with consumer lending, an area where cooperatives have long seen success.

Many credit unions initially target the same types of businesses as every other lender in their market. But the real opportunity is with underserved industry niches, and this is how you can differentiate your small business lending program from the competition.

Think of locally owned small businesses like landscapers, contractors, plumbers and electricians as ideal candidates for your services. These businesses need working capital to support their growth, as well as the ability to finance equipment and vehicles to keep their enterprises humming along.

Once you’ve selected your ideal market niche(s), focus on setting underwriting parameters that fit your institution’s risk appetite. But don’t overcomplicate the underwriting criteria, especially for small-dollar loans. Responsiveness and speed are the key differentiators in small business lending.

For small-dollar loans, leverage an auto approval engine that allows you to deliver quick decisions to applicants in an efficient and timely manner. Research shows that a digital business loan application process can reduce credit underwriting costs by as much as 82%.

You should not over-analyze these loans, especially when targeting businesses that meet all your established criteria. The name of the game is speed and service, so let the technology handle the heavy lifting.

Lastly, be sure to work with a seasoned industry partner that understands small business lending and credit unions, and offers a streamlined technology platform for small-dollar requests. This will enable your business lending department to focus internal resources on larger, more complex loan requests.

With help from an experienced credit union lending partner, your credit union can take on the small business lending challenge in a prudent way with little added risk. You will diversify your loan portfolio, grow interest and non-interest income, and support your small business community, all while building loyal, profitable business relationships for the long term.

In our next article in this series, we’ll discuss how government-guaranteed lending options like SBA 7(a) and Express loans are a perfect complement to your small business services program.