Escape the Squeeze

smiling business owner talks on phone in home office
By John Meyer

7 minutes

There’s a revenue crunch. To grow, pursue small-business services.

Right now, credit unions are looking for ways to bolster revenue for many reasons.

Mortgage and refinance volume is way down. Noninterest income from overdraft fees has declined as the Consumer Financial Protection Bureau continues to scrutinize the practice. And, for the first time since 2007, credit unions are struggling to attract and keep deposits. 

Hit with a triple whammy of lost loan income, lost noninterest income, and their cost of funds increasing, executives are looking to diversify their heavy concentrations in auto lending and attract new deposits. The good news: There are ways to bolster revenue. To grow with a new market segment, consider offering small-business banking.

The Small-Business Opportunity

Even in a downturn, pursuing small business can lead to more deposits and new lending opportuni­ties, as many of them offer recession-proof services that include selling essential or mandatory goods like food, diapers or hardware; providing crucial repairs like plumbing or elec­trical; or serving high net-worth people otherwise insulated from a recession. Because these small businesses have annual revenues of less than $10 million, they are also not likely to have large checking balances that would cause liquidity risks for CUs.

Traditionally, lending to small to medium-sized businesses has been pursued by community banks and fintech companies. The largest small-business lender in the country is American Express with its 2020 acquisition of Kabbage. PayPal ranks as one of the top small-business lenders alongside Mercury, Bluevine and OnDeck. About 580 community banks have concentrations in small-business lending above 20%, according to call report data. But don’t be fooled by that low number. The amount funded by those banks for SMB borrowers is a whopping $72 billion.

For credit unions, the opportunity to get into the market is ripe.

According to the U.S. Small Business Administration, small businesses make up 99.9% of U.S. businesses, employ 47.1% of U.S. employees and produce 60% of job growth. While COVID-19 forced many to close, it also brought a flood of new business applications. 

In 2020, 4.3 million business applications were filed, up 24% over 2019 and 51% over the 2010-2019 average, according to the U.S. Census Bureau. The numbers point to a golden opportunity for CUs to support a blossoming demographic. 

Most small businesses are up against many financial challenges, but most credit unions have yet to prove responsive to their needs. In a study by Phase 5 of the Small Business Pulse Survey by the Census Bureau as reported in The Financial Brand, nearly half of surveyed small businesses had not received any offers of support from their banks and credit unions during the pandemic. Another 14% could not remember if they received any.

Demand is There

In a survey of more than 1,260 small businesses conducted by Cornerstone Advisors during the pandemic, almost 70% of small-business owners said they prefer to borrow from their primary financial institution. In total, the more than 32 million SMBs with less than $10 million in annual revenue in the United States need loans between $5,000 and $1.5 million. Currently, these SMBs are using such funding sources as SBA loans, equipment financing loans or other lines of credit from fintech companies that can promise a quick decision.

Loan spread is there for CUs entering this market. While many loan officers tend to assume rates are the No. 1 driver for loan opportunities, a study by Cornerstone Advisors in 2022 found the opposite. Small-business owners will and do use fintech firms with higher rates. They are willing to pay more if the money from the loan comes more quickly.

Loan spread is there for credit unions entering this market.

Finding Success

So how can a CU execute a solid business services plan to create new revenue? The effort will take strategy, people and technology working in tandem.

1. Pick your strategy. Choose whether your CU wants to be industry-agnostic or a niche player. If industry-agnostic, ask whether your CU is focusing on equipment loans or other loans like for working capital up to a threshold. Many institutions use the North American Industry Classification System to choose industries about which they will become experts. Take Nerve, for example—the banking app for “creators” powered by Piermont Bank. This fintech is targeting musicians, artists, chefs, etc. with business checking, payments and invoicing to drive deposits. Other institutions fund loans for construction companies, medical and dental offices, and other small businesses that need equipment loans from $5,000 to $1 million.

2. Form the team. After you’ve selected your niche, employ people who can effectively attract new business deposits and loans. At a minimum, your CU should appoint a leader (director level or above) to run the group and work in lockstep with a product manager who helps select the products to offer, including accounting/bookkeeping, bill payment, and deposit, loan and cash management services. 

Next, your credit union needs to determine if it will hire relationship managers to manage lines of credit above a certain threshold. If it does, these relationship managers need to form connections with people like accountants who file taxes for small businesses, bookkeepers who handle invoicing, people who help with business licensing, and clubs where small-business owners network, such as Kiwanis or Rotary. As a head of business banking told us in our interviews, “Wells Fargo will not assign a relationship manager unless the small business has at least $6 million in annual sales. We found a whole market of profitable small businesses under $6 million in revenue that want a human to assist them.”

3. Deploy technology. The challenge for CUs is to match the experience offered by fintech firms utilizing technology to differentiate their products. The most successful SMB lenders deploy technology to enable: 1) prequalification of SMB borrowers, 2) a digital application experience, 3) digital identity verification to comply with know-your-customer rules and beneficial ownership capabilities, 4) auto-decisioning by analyzing bank transactions and cash-flow calculations, 5) documentation creation and electronic signing, and 6) account boarding.

Most U.S. CUs do not have an automated commercial loan system. Many system providers are now working to make the SMB lending market more profitable by automating the entire workflow, including auto-decisioning of loans under a certain dollar threshold. CUs are already deploying these auto-decision engines for consumer lending. Leveraging this tech for small businesses makes great sense when you consider that a Cornerstone study found that a business owner’s credit score is the primary factor for loan decisions under $250,000. 

Many SMBs lack years’ worth of tax returns and income statements. That’s why the new auto-decision technology that enables using bank statements or alternative sources of data to aid in determining credit risk is so key. Besides significantly lowering the cost of underwriting, auto-decision engines also improve approval turn time. Faster loan decisioning helps CUs mimic the 24- to 48-hour approval often offered by fintechs.

4. Alternatively, partner with a fintech company. Some CUs might instead opt to partner with fintech companies that source these loans and need sponsor institutions to make the actual loans. 

According to Cornerstone Advisors’ “2023 What’s Going On In Banking” report by Ron Shevlin, 47% of institutions have partnered with at least one fintech firm to help deliver new services. Some companies, such as Lendio or Smartbiz, have built partner networks to help institutions use their technology to source and make decisions on SMB loans.

Bottom Line 

More credit unions today need to find new sources of deposits and loan volume. An avenue for many is to explore the small to medium-sized business market and decide whether their CU has the strategy, people and technology in place to succeed in this market that wants to do business with a local credit union.  cues icon 

John Meyer is senior director with CUESolutions provider Cornerstone Advisors, where he helps community banks and credit unions use data to make smart decisions with risks and opportunities.

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