SHREVEPORT, La.—Credit unions' interest in new lending streams and small businesses' need for operating capital are making micro-loans a growing opportunity for CUs.
Micro business lending-loans of less than $50,000 for commercial purposes-can be the lifeblood of small enterprises. Often the loans are made for less than $15,000 and used for a wide range of purposes, including cash flow, new equipment, delivery vehicles and money to expand the workforce.
At Shreveport FCU, Helen Godfrey-Smith explains the CU's micro-lending program has taken off since it was introduced just over two years ago. The program, which has more than 100 loans on the books, averages about four deals a month, each with balances typically between $20,000 to $40,000. The CEO said the CU could do many more micro-loans if it had additional staff and marketed the program.
"I think we could do five times the number we are doing now," said Godfrey-Smith about the market demand. "The loans are for all kinds of purposes-18 wheelers, freezers for a farmers market, expanding a beauty school... This is a lending area I think credit unions have not tapped. If you are careful about your underwriting, this can be a real ongoing money maker."
Looking For Loans
Federal Reserve data shows that of all small businesses looking for loans, 41% are seeking less than $50,000. Yet, as of year-end 2011, only 9.7% of all credit unions offered micro-loans according to CUNA data.
"The biggest barrier to growth for small businesses is access to capital, and we are not talking about million-dollar land deals," said Ben Rogers, research director at the Filene Research Institute in Madison, Wis., which just completed a micro-lending study.
Data from the 2008 U.S. Census show that businesses with zero to four employees comprise 88% of all businesses in the United States. They employ 28.6 million people, or roughly 25% of the nation's workforce.
"Many of these businesses are right in credit unions' backyards," said Rogers.
Stacy Augustine, president of CU Strategic Planning, Tacoma, Wash., sees demand for the small business loans getting bigger. Her company writes grant applications for community development financial institutions, and often now that money is directed to fund micro-lending programs. "This is a good loan for credit unions."
Micro-loans, while carrying more risk, offer greater margins than standard consumer loans with rates often in the 5% to 8% range depending on the purpose. Jim Gallagher, president and CEO of Member Business Solutions, a business lending CUSO in Tallahassee, Fla., said CU attention in his area is rising. "We are seeing many more of these types of loans and getting calls from CEOs about them-typically from credit unions from $10 million to $50 million in assets."
Analysts noted that many credit unions have been making these kinds of deals for years in the form of personal loans, personal lines of credit and credit card limit extensions that go to business needs. But that approach not only shortchanges borrowers by limiting funds they can draw, it also challenges the credit union since the loans are not recorded, or underwritten, as a business loan, adding to risk.
For CUs bumping up against the MBL cap, micro-loans are attractive because they are not MBL loans, as long as the total account loan relationship is below $50,000. They also do not require stringent MBL paperwork.
Time Investment
Godfrey-Smith acknowledged that her $102 million shop with 2.5 staff working on micro-lending can't keep pace with demand. She explained that the loans require a reasonable time investment due to each one being unique.
"Staff time is the downside. If these loans were at all similar, we could assign a process to them-like do A, B and then C. We could handle more volume."
What is adding to the attractiveness of Shreveport FCU micro-loans, the CEO said, is the credit union will "hand hold" businesses throughout the borrowing process. Several sources indicated that small businesses are often unprepared to borrow.
"Sometimes the first micro-loan we make to a business is just to pay an accountant to gather tax and other information," said Godfrey-Smith.
The amount of time invested and the loan amount, experts say, have turned some commercial banks away from this market. Bill Myers, director of NCUA's Office of Small CU Initiatives, said that without credit unions filling this lending void, many small businesses will struggle and fail.
"They are pushed out of the business lending space until they get bigger. If credit unions are willing to pay attention to these small owners and treat them like adults, this is a substantial market."
In Miami Lakes, Fla., JetStream FCU has funded more than $3 million of micro-loans in the last two years with $7 million in the pipeline. "We get a lot of requests, but we have to be conservative due to our size. We are limited in the risk we can take on," said Jeanne Kucey, CEO of the $158 million institution.
Leading To Bigger Things
The loans have done well for JetStream, beyond just the dollar amounts. Kucey said, as did Godfrey-Smith, the small loans can lead to bigger things-such as ancillary services and new members from business employees, especially once the enterprise grows.
Kucey shared how supporting local Edda's Cake Company with micro-loans throughout the recession has built a strong relationship that could lead to a large, million-dollar-plus business loan (see related story on this page).
"This is a company that years ago started out by baking cakes in the family home. Now they are a multi-million-dollar business with several retail outlets and a wholesale distribution center that delivers cakes to a number of big-box retailers," said Kucey. "You never know what a small business might grow into."
While micro-loans are not subject to tight MBL rules, they are considered business loans by NCUA, the agency emphasized. Industry insiders and analysts agree that looking at these loans as anything else brings more risk to the credit union.
Experts recommend that credit unions making micro-loans should have someone on staff with business lending experience, use business lending forms and not consumer loan paperwork, spend time on underwriting and risk price accordingly, dig deeper than credit score and focus on collections-call as soon as the payment is late.
Dave Grace, managing partner at Dave Grace Associates, Madison, Wis., and author of the Filene micro-lending study, recommended that credit unions partner with community business development agencies to make sure the small enterprises receive the business planning assistance they need.
All In
"If you get into micro-lending you should be all in. Think about the scope of services small businesses need, not just the loan-tax preparation, developing business plans, cash management..." said Grace, who emphasized these are keys to making sure the business starts well and remains viable.
For the a CU's micro-lending program to remain strong, Gallagher cautioned that while micro-loans do not fall under MBL guidelines, they should always be treated as business loans. He pointed out that NCUA guidelines state that once the small business loan relationship goes beyond $50,000, loans above the $50,000 cap are considered an MBL. Failure to pay attention to that rule can lead to problems with examiners and members, he added.
"So Joe the plumber comes in for a $25,000 equipment loan and then, with that loan still outstanding, he comes back for $35,000 more. Now that second loan has to be completed under standard MBL application rules. You could alienate the member-he comes in once and the loan is signed on a one-page document and out he goes. Next time he has to come up with three years of tax returns, a business report . . . He might ask, 'What's going on here?' Always use the same process, no matter what the exposure, for applying for these loans. Don't document a business loan with consumer loan documents."
NCUA's Myers said CUs might be "misled" to think that under $50,000 examiners are not going to take the loan seriously or call it a business loan. "That simply is not correct. No matter how big or small, if the loan is for business purposes we look at it as a business loan."
He encouraged credit unions to "buy the whole package and do this right. Do that and this is a wonderful opportunity. If you look at micro-lending as doing business loans on the fly, it will be a horrible deal. The regs will come back to haunt you-the examiner will say you did a business loan and no matter how small you did not evaluate it properly and will write you up."
Both Shreveport and JetStream report 0% delinquencies in their programs, far below the 2.75% average for micro-loans according to the Aspen Institute, which has been evaluating micro-lending for two years. Both CEOs cite two reasons for their good fortune: businesses feeling a sense of loyalty to the credit union for lending to them when other FIs would not and moving slowly with micro-lending.
"We are conservative with the program," said Godfrey-Smith. "We look at the first two years as a seasoning period, to see how the loans are performing, and they have performed well. We did not want to rush into this and draw any concerns from our regulators or our members. We do not want to tarnish our excellent reputation by not being able to keep up with member demand for this product."
Micro-lending interest is growing among members and credit unions. Filene Research Institute's Rogers said his organization's micro-lending study in its first month became the most downloaded report in the research institute's history.
NCUA's Myers suspects CUs are seeing a long-term opportunity to build lasting relationships and bolster lending.
"If you look at this opportunity longitudinally, small business is where bigger business comes from. You are developing loyal members who will stay with you for years, will take multiple borrowings, provide deposits and likely other business. These are people who want to work with you, and you can build very strong ties. And, too, if the credit union needs a little free marketing, the business will probably let you put your sign in their window."
