5 Critical Components for Construction Lending Success


lending-12-31-18.pngThe tough reality is that bankers are experiencing margin compression due to the current state of the yield curve and rising interest rates.

Without refinances to process, and new mortgages growing rarer, they must rely on other types of loan products. Enter construction loans.

Construction lending was once a vital part of a healthy loan product mix. Of course, many bankers will point directly at TRID, or the Know Before You Owe mortgage disclosure rules, as their roadblock to originating construction loans. Support for TRID, like many other regulatory rules, hasn’t been prevalent in the industry, and some bankers don’t have the information they need to mitigate risk.

So what now? Who is offering support for these regulations? And how can lenders begin construction lending again?

Instead of giving up on construction lending, most community banks have all the resources they need to start and maintain a successful construction lending program; it’s all at their fingertips.

To become successful in construction lending, you need these five components to all work together:

1. Support in the C-suite and boardroom
Before looking at solutions, your board must have a consensus on whether or not to even launch the program. Construction lending programs require effort from several C-level executives and the board. Everyone in the C-suite and boardroom need to be on the same page. Having this consensus helps assemble and maintain a successful program.

2. Your Loan Origination System (LOS)
Sometimes lenders don’t know where to begin with a construction loan program, particularly with respect to staying compliant with TRID. It can surprise lenders that the fields and forms required to support construction loans may be available through their LOS. Work with your LOS provider to diagnose how other lenders have utilized the LOS platform when offering construction loan products, particularly the production of the lender’s estimate (LE) and closing document (CD). If your LOS solution does not support construction loans, there are other workarounds in order to still reach the end goal, such as using a document service provider.

3. Specialized document service provider
Mitigating risk and pleasing all who are involved in a construction loan isn’t easy given how many moving parts are involved. It can be done with the proper resources. Document service providers are one of the most important elements to have. The provider gives lenders the specific form needed for each step of the project, no matter if the project is down the street or across state lines.

Before you sign on with any document service provider, make sure of three things:

  • They are able to produce both the LE and CD, particularly if your LOS doesn’t provide them. 
  • They are able to provide the state-specific documents that are going to be needed in the closing package.
  • They are able to guarantee that their documents will protect your first lien priority in each state.

4. In-house subject matter expert
Before the financial crash 10 years ago, construction loan expertise was abundant. But a decade after the recession, experts on construction lending can be difficult to find inside the bank. Finding or recruiting somebody like this on your team can be an amazing resource. They can be helpful in educating other lenders and assist in problem-solving loan structuring to benefit the entire company.

5. Post-close draw management and servicing
How do you manage the cost and process involved after you close that construction loan? Loan servicing is an integral piece of construction lending, and it is very hands-on and specific. Once the loan is closed, someone must be servicing this loan to ensure success for the duration of the construction loan: managing first lien priority, draw administration, inspections, and communication with key stakeholders such as the borrower and contractors. At the end of the day, you need someone to manage the lenders’ holdback, while simultaneously protecting the physical, financial, and legal interests of your bank.

Beyond Spreadsheets: Digitizing Construction Lending



Many banks rely on spreadsheets and personal contact to oversee and manage construction loans—methods that are ineffective today. How can financial institutions improve this process? In this video, Built CEO Chase Gilbert explains how upgrading technology and making the process digital creates efficiencies for both bank and borrower, and allows for better risk management capabilities.

  • Why Digitize Construction Lending
  • Efficiency Gains and Other Benefits
  • Confronting Common Obstacles

Five Reasons Why You Should Reconsider Short-Term Loans


lending-7-16-18.pngFor the better part of a decade, regulatory agencies have placed obstacles in front of banks that all but prohibited them from offering short-term, small-dollar lending options for their customers. Now, at least one major regulator has signaled a shift in its opinion about those products, which should inspire banks to reconsider those options.

Here are five reasons banks often cite when discussing why they don’t offer short-term, small-dollar options, and a case why they should rethink those ideas.

You don’t think your customers need it
Perhaps many of your branches are in affluent areas, or you believe that your customers have access to other types of short-term liquidity. But the statistics regarding American personal finances may surprise you:

Nearly 50 percent of American consumers lack the necessary savings to cover a $400 emergency, according to the Federal Reserve.
The personal savings rate dipped to 2.8 percent in April 2018, the lowest rate in over a decade, according to the St. Louis Fed.
Each year 12 million Americans take out payday loans, spending $9 billion on loan fees, according to the Pew Charitable Trusts.

Based on these statistics, it’s likely that a portion of your customer base is affected by the lack of savings, or has a need for better access to liquidity, and chances are good that they’d be receptive to a small-dollar, short-term loan solution.

It’s Cost and Resource Prohibitive
For most financial institutions, introducing a traditional small-dollar loan program is cost-prohibitive–operationally, and from a staffing standpoint. From the cost of loan officers and underwriters to the overhead, the reality is it would take time and resources many banks do not have.

Enter fintech firms, bringing proprietary technology and the application of big data. The right fintech partner can manage the time, human and financial resources you may not have, such as application, underwriting and loan signing processes. In some cases, the whole thing can be automated, resulting in a “self-service” program for your customers, eliminating the human resource need.

Underwriting Challenges and Charge-Off Concerns
Another challenge is the loan approval process and how to underwrite these unique loans. A determination of creditworthiness by a traditional credit check does not adequately predict the consumer’s current ability to repay using recent behavior instead of a period of many years. Today’s fintech firms use proprietary technology to underwrite the loans, incorporating a variety of factors to mitigate charge-offs.

The OCC recently released a bulletin outlining “reasonable policies and practices specific to short-term, small-dollar installment lending.” It stated such policies would generally include “analysis that uses internal and external data sources, including deposit activity, to assess a consumer’s creditworthiness and to effectively manage credit risk.” The right fintech partner will apply big data solutions to assess creditworthiness using the OCC’s criteria and other factors.

Compliance Burdens
There’s no question short-term loan options have been heavily regulated over the past eight years. The CFPB placed predatory lending and payday loans under scrutiny. In 2013, the OCC and FDIC effectively ended banks’ payday loan alternative, the deposit advance. The CFPB cracked down even harder in October 2017 with their final payday lending rule, which had the potential to devastate the storefront payday loan industry, forcing consumers to seek alternative sources of quick liquidity.

The pressure is easing. The OCC was the first agency to encourage banks to make responsible and efficient small-dollar loans. If history has taught us anything, it’s that the other regulatory agencies likely will soon follow suit.

Concern About Cannibalizing Overdraft Revenue
Exclusive data collected by fintech firms experienced with overdraft management has shown there are two distinct groups of consumers managing their liquidity needs in different ways:

The Overdrafters
These are consumers that struggle with transaction timing and incur overdraft or NSF fees. A significant portion of this group might have irregular income streams, such as small business owners or commissioned salespeople. In many cases, these consumers are aware of their heavy overdraft activity, and will continue to overdraft, because for them, it makes financial sense.

The Loan-Seekers
A second group includes those consumers who simply lack the cash to promptly pay their bills, and either can’t obtain adequate overdraft limits or failed to opt-in to overdraft services. These consumers are actively seeking small-dollar loans to avoid the double whammy of hefty late fees and negative hits to their credit score for late payments.

Savvy financial institutions will ensure they have the programs in place to serve both groups of consumers, and fill the gap for the second category by using an automated small-dollar lending program with sound underwriting from a trusted fintech vendor.

Rethinking the FICO Score


FICO-6-20-18.pngFor decades, pre-dating many banking careers today, the tried and true method to evaluate credit applications from individual consumers was their FICO score. More than 10 billion credit scores were purchased in 2013 alone, a clear indicator of how important they are to lenders. But is it time for the banking industry to reconsider its use of this metric?

The FICO score, produced by Fair Isaac Corp. using information from the three major credit bureaus—Equifax, TransUnion and Experian—has been considered the gold standard for evaluating consumer credit worthiness. It focuses squarely on the concentration of credit, payment history and the timeliness of those payments. FICO scores have generally proven to be a reliable indicator for banks and other lenders, but in an age operating at light speed, in which many purchases can be made in seconds, a score that can fluctuate in a matter of days might be heading toward obsolescence.

Some believe a person’s credit score should be considered only in parity with other, more current indicators of consumer behavior. A study released in April by the National Bureau of Economic Research says even whether people choose an Apple or Samsung phone “is equivalent to the difference in default rates between a median FICO score and the 80th percentile of the FICO score.”

Consider the following example. A consumer pays off an auto loan, resulting in a reduction in their FICO score. This is largely due to the reduced amount of credit extended. That reduced score could become a deciding factor if the customer has applied for, but not yet closed, a mortgage 60 or so days before paying off the vehicle and could affect the interest rate of the applicant.

That leaves a bitter taste for anyone with average or above average credit who has demonstrated financial responsibility and, it could be reasonably argued, would be a much better candidate for credit extension than someone with the same score who doesn’t give two flips about the regular ebbs and flows in their credit.

For all its inherent benefits to the industry, the traditional credit score isn’t perfect. Banks could be using their own troves of customer data to evaluate their credit applications more accurately, more fairly or more often. This could be a boon for institutions hoping to grow their deposit base or enhance their loan portfolios. Some regulators have indicated their attention to this approach as well. The Federal Deposit Insurance Corp.’s Winter 2017 Supervisory Insights suggests data could be a helpful indicator of risk and encouraged member institutions to be more “forward-thinking” in their credit risk management.

“As new risks emerge, an effective credit [management information system] program is sufficiently flexible to expand or develop new reporting to assess the effect those risks may have on the institution’s operations,” the agency said.

That suggests the FICO score banks are currently using might not tell the full story about how responsible credit applicants might be.

“My personal opinion is that among most people, if you have someone who thinks about [their digital footprint and credit], you’re already talking about people who are financially quite sophisticated,” Tobias Berg, the lead author of the NBER study and an associate professor at Frankfurt School of Finance & Management, told Wired Magazine recently. The study examined a number of data points that go far beyond what is incorporated in a FICO score.

That certainly has value for banks. The data they already collect about their customers could be used to determine credit worthiness, but there’s a counter argument to be made. Digital footprints are much easier to manipulate more quickly over time by changing usernames, search history, devices and the like. Using an Android over a more expensive iPhone could be a negative in the study’s findings, for example, which might not reflect the customer’s true credit profile.

But FICO scores are not reviewed as regularly as they could be, and a swing of a couple dozen points from one moment to another can significantly sway some credit applications.

For now, fully abandoning the FICO score isn’t a likely or manageable option for banks, nor one that’s favored by regulators, but the inclusion of digital data in credit applications is something that could be adapted and be beneficial to both the bank and customers eager to expand that relationship with their institution.

Enhancing the Lending Process Through Data



Customers today expect quicker decisions, and data can empower banks to improve the customer experience. Data can also enable growth as banks gain more and better information about their customers. In this video, Steve Brennan of Validis outlines how banks can confront the challenges they face in making the most of their data.

  • How Data Has Transformed Lending
  • The Benefits of Leveraging Data
  • The Challenges Banks Face
  • Addressing Data Deficiencies

Why Your Bank Should Be Watching Amazon


amazon-7-7-17.pngCould Amazon be a threat to banks? The online retailer announced in June that its Amazon Lending program, a small-business loan service that the company began offering in 2011, had surpassed $3 billion in loans globally, to more than 20,000 small businesses. One-third of those loans—$1 billion—were created in the past year, making it larger than most small banks.

Competition from nonbanks in small business lending isn’t new. But while lending startups in the past have often excelled in technology, they struggled to gain customers, and funding was more expensive than for traditional banks. In contrast, banks have had the expertise and relationships, and can fund loans more cheaply.

Amazon’s loan growth may represent a new phase in loan disruption, according to Karen Mills, a senior fellow at Harvard Business School and former head of the U.S. Small Business Administration.

“Having a pipeline into a set of small business owners who are doing business with the platform, knowing a lot of data about their business, could very well be the equivalent of a customer pipeline that’s unparalleled except at some of the most important traditional banks,” Mills says.

Amazon isn’t putting banks out of business, at least not in the foreseeable future. While 20,000 small businesses and $3 billion in loans is nothing to sneeze at, the program is invitation-only and limited to Amazon sellers, with the company leveraging its data on its client businesses to make credit decisions.

“Amazon looks at everything as basically a use case,” says Steve Williams, a partner at Cornerstone Advisors, based in Scottsdale, Arizona. “Is it something that we can do that the customer would want, can we technically deliver it, and can we make a business out of it?”

Banks should prepare for a reality, led by companies such as Amazon, where customers expect rapid credit decisions and an easy loan process. An employee describes the lending process as “three fields and three clicks” in a video published by Amazon in 2014.

“You can’t waste your customer’s time, and Amazon is relentless in trying to make things easier for its partners and customers,” says Dan O’Malley, the chief executive officer at Boston-based Numerated Growth Technologies, which spun off from Eastern Bank’s lab unit in May. That unit developed an express business loan program for the bank, and banks can now license the lending platform through Numerated.

Mills recommends that banks examine whether they want to grow their small business lending portfolio and if so, examine if they can provide the platform in-house or need to use an outside company.

Banks have been increasingly partnering with fintech firms, but Amazon’s suitability as a partner is debatable: O’Malley says Amazon is notoriously difficult to work with. But Amazon seems open to relationships of convenience. JPMorgan Chase & Co. offers an Amazon Prime Rewards Visa credit card, which gives 5 percent cash back to Amazon Prime members on their Amazon.com purchases. BBVA Compass has been testing the Amazon Locker program in its Austin, Texas, branches, so Amazon customers can safely and conveniently pick up their orders. Presumably, this would drive more traffic to BBVA’s branches.

And there’s Alexa, Amazon’s voice-operated digital assistant, which is used in Internet-enabled speakers such as the Echo. So far, Capital One Financial Corp. and American Express are among the few financial institutions whose customers can use Alexa for tasks like making a credit card payment or getting details on spending.

Amazon sees promise in its voice-enabled devices. “We’re doubling down on that investment,” Chief Financial Officer Brian Olsavsky said in Amazon’s first quarter 2017 earnings call. With the Echo, Dot and Tap products, Amazon has about 70 percent of the smart speaker market cornered, according to TechCrunch.

“Voice commerce and having to deal with voice as a channel is an important thing that [banks] are going to have to figure out,” says James Wester, the research director responsible for the global payments practice at IDC Financial Insights.

Amazon likely doesn’t have its sights set on becoming a bank—at least not for now, says Wester. But the company’s customer-first approach to improving processes is setting the tone for commerce, and if Amazon thinks it can make life easier for its customers and make money doing it, it won’t shy away from competing with the banking industry.

The possibilities are endless. Amazon unveiled its Amazon Vehicles webpage as a research tool for consumers in 2016, and the retailer is gearing up to sell cars online in Europe, according to Reuters. “There’s no reason that people won’t say, ‘I’m going to buy my car through Amazon and finance it,’” says Cornerstone’s Williams. Auto loans may very well be the next financial product on Amazon’s radar, and then, what’s next?

The People Who Plan to Change Financial Services


Changing-Banking-FXT.png

This article originally published inside The FinTech Issue of Bank Director digital magazine.

The world is filled with technology companies hoping to transform the financial industry. Of course, very few of them will. Not all ideas can overcome the substantial hurdles to become major commercial successes. We are not proposing here at Bank Director digital magazine to tell you who will be a success and who won’t be. But we do want to introduce you to some of the entrepreneurs who are proposing to reshape the world as we know it. These are people whose ideas are re-envisioning platforms and processes, people who are simplifying, unifying and upsetting conventional practices. These entrepreneurs really are shaking up traditional boundaries to help us all think about banking a little differently.

Christian Ruppe and Jared Kopelman

They are creating the driverless car of banking.

Using machine learning, this duo, who met as students at the College of Charleston, have built a platform for banks and credit unions to help millennials save without even thinking about it. Frustrated that fellow college students would get on a budget and then abandon it a few weeks later, 22-year-old Ruppe thought he could make the attainment of financial stability easier. Achieving financial health takes discipline and focus, like weight loss. But Ruppe reasoned that technology could help with financial health so it wasn’t so dependent on discipline and focus. If he could come up with a way to automate savings, debt payments and investments, many more people could realize the benefits of compounding over time to create wealth. “We are the self-driving car of banking,’’ Ruppe says.

There are several other automated savings applications on the market that use machine learning, such as Digit and Qapital, but most of those are sold directly to consumers, rather than through a financial institution. Monotto’s private label approach means the customer doesn’t pay for the product and never knows the platform doesn’t come from the bank. Monotto, a play on the words “money” and “auto,” can be integrated into mobile banking or online applications, sending well timed messages about refinancing the mortgage or buying a house, for example. Bear State Financial in Little Rock, Arkansas, a $2.2 billion asset bank, already has agreed to pilot the program. When customers sign up, the algorithm learns from their spending patterns and automatically pulls differing amounts from their checking accounts into their savings account using the bank’s core banking software, taking into consideration each customer’s transaction history. Individuals can set savings goals, such as buying a house or a car, and the platform will automatically save for them. For now, Monotto has received funding from friends and family, as well as an FIS-funded accelerator program. Eventually, the founders envision a platform that will also help you invest and pay down debt.

“You have someone who is solving a problem [for society] but figuring out how to solve it for the bank, as well,” says Patrick Rivenbark, the vice president of strategic partnerships at Let’s Talk Payments, a research and news site.

Zander Rafael

This student lender calculates the school’s ROI to determine eligibility for a loan.

With the rising cost of tuition, students who take out loans end up with an average of $30,000 in debt after college, leading to rising rates of delinquency. But what’s holding the schools accountable?

Alexander “Zander” Rafael, 32, and his team created Climb Credit in 2014 to service student loans based on the returns the college provides its graduates. This places Climb among a menagerie of fintech startups, like SoFi, LendEDU and CampusLogic, all trying to serve the student loan market.

Climb, which funds its loans through investors, stands out because it only works with schools that have a record of landing students jobs that “pay them enough to [cover the] cost of tuition,” says Rafael. In addition to evaluating the student, Climb also assesses the schools. If the institution passes Climb’s graduation and return on investment analysis, then its students are eligible for Climb loans and the school takes on some of the risk of the loan, receiving more money if more students pay them back.

Climb has grown by focusing on more non-traditional learning environments, like coding boot camps, where students invest $10,000 for a yearlong program to learn web development. According to Climb’s analysis, many of these students land jobs that pay up to $70,000. “The return was very strong,” says Rafael. Climb now works with 70 schools, including some two and four-year university programs.

Schools benefit because they can accept students that lack cosigners and who otherwise may have struggled to find a private loan elsewhere. Climb charges an average of 9 percent APR for the loans, but it can range from 7.59 percent to 23.41 percent.

With a $400 million lending capacity, Climb has raised a Series-A funding round of $2 million. But the idea has shown early promise, as Rafael adds that profitability is “within line of sight.”

Ashish Gadnis

Could this man be the Henry Ford of identity?

What if you could unlock trillions of dollars of wealth that could be associated with individuals around the globe? What sort of opportunities would be there for banks and businesses of all sorts? BanQu cofounder Ashish Gadnis saw first hand the problem facing billions of people worldwide who don’t have a bank account when he tried to help one woman farmer in the Democratic Republic of Congo. “The banker said, —We won’t bank her, but we’ll bank you, Mr. Gadnis,’” a native of India who grew up in poverty himself. “They wouldn’t recognize her identity,’’ he says, despite the fact that she owned a farm and had income every year from her harvest. Gadnis and cofounders Hamse Warfe and Jeff Keiser say this is a problem that confronts 2.7 billion people around the world who don’t have access to bank accounts or credit because they don’t have a verifiable identity. Gadnis, who wore a giant cross in lieu of a tie to a recent conference, promises to change all that by providing a way for people to create their own digital transaction-based identity through an open ledger system, or blockchain. Others in their network can verify transactions such as the buying and selling of a harvest, or the granting of a job. He estimates that approximately 5,000 people, some of them living in refugee camps in the Middle East, are using the technology to create a digital identity for themselves that could open up future opportunities to obtain credit and enter the global economy.

It’s not a nonprofit company, as you might think. BanQu is in the middle of a Series A venture capital funding round, and envisions banks and other financial institutions paying for the platform so they can access potential customers. It’s free to users. Like other tech entrepreneurs, he is optimistic about the potential of his platform, perhaps wildly so. “The key to ending poverty is now within our reach,’’ he says. But he has quite a few admirers, including Jimmy Lenz, the head of predictive analytics for wealth and investment management at Wells Fargo & Co. Gadnis has credibility, Lenz says, as he sold a successful tech company called Forward Hindsight to McGladrey in 2012. “When I think about Ashish, I think about Henry Ford. We think about Henry Ford for the cars. But really, his greatest achievement was the assembly line, the process.”

Nathan Richardson, Gaspard De Dreuzy and Serge Kreiker

These entrepreneurs provide anywhere, anytime trading for brokerage houses and wealth management firms.

All three of these individuals have well established backgrounds in technology, including Richardson, who was formerly head of Yahoo! Finance. Now, they are using application programming interfaces, or APIs, to try to make it easier to trade no matter the platform or where you are. Instead of logging into a brokerage firm’s website, Trade It sits on any website and lets you trade your brokerage account inside the website of a publisher or other company, such as Bloomberg. Although many banks have yet to sign up to use the app, the company is licensing the software to brokerage houses and Citi Ventures, the venture capital arm of Citigroup, invested $4 million into the company in 2015. “The thing that impressed us is taking financial services to our customers in the environment they are in, rather than expecting them to come to us,’’ says Ramneek Gupta, the managing director and co-head of global venture investing for Citi Ventures.

Publishers like the app because it doesn’t take the customer outside of their site. Brokerages like it because they can reach their customers anywhere. “If you think about 70 percent of consumers under the age of 40 who trust Google and Facebook more than their financial institution, why wouldn’t you want to put your product there?” says Richardson.

Gupta thinks this speaks to the future of financial services. “You have already seen it elsewhere,’’ he says. “You can order Uber from inside Google Maps.”

Five Ways to Improve Your Bank’s Commercial Lending Department


commercial-lending-5-27-16.pngWhen running a business, one of the most important things an owner needs is access to capital. Unfortunately, getting their hands on that much needed capital is never easy, quick or painless. In fact, it’s quite the opposite. But the experience doesn’t have to be all bad. If you are a lender, consider these five steps to stand out from your competitors.

Be Convenient
For people who own or run a business, many times it is their passion (or their obsession) and most spend 60 plus hours a week tirelessly working on making that business a success. The last thing they have time for in the middle of the day is to run to the bank to talk about their borrowing needs. Provide your business customers with a way to explore and even apply for a loan outside of the scope of normal bank hours and in a way that leverages technology as a productivity enabler. In this instant online access world, banks need to provide their customers convenience, and technology is essential to that.

Be Fast
When the need for capital arises, most business owners needed it “yesterday” rather that “six to eight weeks from now.” Let’s face it, in the world of banking, we’re always thorough, but we’re not always quick. The time to process most loans, from application to funding, can take a very long time. One of the biggest negative influencers on the customer experience is the frustration borrowers have to deal with as the lending process drags on. Through automation, banks can streamline lending processes without compromising their credit requirements. Leverage technology by integrating resources for data collection, underwriting, collection of the required documentation as well as closing and funding.

Be Easy to Work With
It takes a lot of time and energy just to complete a loan application. And it’s by no means over once the business owner gets approved. Streamline and automate your application loan processing workflows as much as possible to eliminate tedious re-keying of the same data over and over again, or requiring applicants to fill out or review elements of the application that don’t apply to them. Provide a way for clients to get the bank what it needs, including bank statements, tax returns, financials etc., in a simple, automated and timely way by integrating technology where possible.

Be Aware of the Big Picture
Business owners are coming to you for more than just a loan. They want help running their business and welcome any advice or value-added information the bank provides. Know that the loan is only one part of the picture. Understand what the capital means to the business. What does the new piece of machinery mean for the long and short term of the company’s performance? How will the extra employees impact the growth of the company? How does what you are doing for the business enhance both the business and personal side of the relationship? To really be a trusted advisor, ask questions that focus on the benefits the business will realize from engaging with the bank. Create a loan process that allows bankers to focus their time on helping customers. Bankers should be building relationships, cross-solving, and maximizing the bank’s share of wallet instead of spending their time spreading numbers and chasing down documents.

Be Prepared
Study after study has proven the the main difference between a top performing sales person and an average producer is the amount of time they spend “preparing” for a conversation with a business owner. The more prepared a banker is, the better the customer experience. Being prepared means doing your homework and understanding the business, the industry, the business owner, and the local economy, for starters. The more prepared a banker is, the more help they can provide and the more value they will bring to the relationship.

With every bank knocking at the doors of the same businesses, competition for quality customers has never been more intense. Follow these five simple steps to set the customer experience your bank delivers above all the rest.

Opening the Consumer Lending Market for Community Banks


As recently as 1990, community banks had a 79 percent market share in consumer lending. Today, that share has dropped to just 8 percent as the biggest banks have capitalized on economies of scale to displace community banks. As a result, many community banks no longer have viable independent consumer lending businesses. Brian Graham, chief executive officer of Alliance Partners, an SEC-registered investment adviser that provides administrative services to BancAlliance and advisory services to BancAlliance members, explains how BancAlliance has partnered with Lending Club to offer community banks the chance to participate in this $3.2 trillion market.

Why did BancAlliance get into consumer lending?
BancAlliance exists to serve the goals of our member community banks, and those members have been asking us to explore approaches that would let them compete with the biggest banks for consumer loans. Based on extensive diligence and audits of potential partners, we have joined with Lending Club due to the scale and quality of its consumer finance business. 

How can community banks compete with large national banks in consumer lending?
BancAlliance allows community banks to collaborate, pooling their individual capabilities. Collectively, we are taking advantage of Lending Club’s highly efficient and advanced servicing and origination functions in order to provide our member banks a “plug and play” consumer finance platform. BancAlliance members can mimic the economies of scale that larger national banks experience by utilizing the tools Lending Club has had in place for years. Recent OCC guidance has encouraged community banks to “achieve economies of scale and other potential benefits of collaboration” in a January 2015 paper, and BancAlliance offers banks an opportunity to join together with a premier name in consumer lending.

Why Lending Club?
Lending Club is the market leader among lenders in unsecured consumer installment credit. Lending Club, which recently went public, is very focused on regulatory compliance matters, given that it works with several bank partners in addition to BancAlliance. Lending Club has well-defined policies and procedures that BancAlliance has validated through several outside reviews. BancAlliance believes Lending Club is a strong partner and is well-positioned to work with us and our members to help them return to their consumer lending roots. Additionally, Lending Club has stated that forming partnerships with community banks is a critical strategic activity, and is focused on fully developing the BancAlliance relationship.

What does this partnership entail?
BancAlliance partnered with Lending Club to allow community banks to offer their customers very competitive consumer loans, as well as to provide an opportunity for BancAlliance members to purchase bank-quality consumer loans from Lending Club’s platform. The joint nature of this relationship allows both parties to benefit from the other’s strengths.

What benefits does this partnership bring to bank customers?
For most bank customers, the interest rate on the consumer loan is well below that on credit cards or other debt. Lending Club provides consumers with a simple, fixed-rate product without teaser rates that can cause a consumer’s debt service to increase unexpectedly. On average, consumers borrowing on the Lending Club platform experience savings equivalent to 32 percent when compared to high-rate credit cards. In addition, since these loans are fully amortizing, the program puts customers on a path to reduce debt and improve their financial outlook and credit. According to Lending Club historical data, customers that take out a loan see an average FICO score increase of 23 points within three months of obtaining a Lending Club loan.

What benefits does this partnership bring to BancAlliance?
First, BancAlliance member banks benefit from the broader and deeper relationship with their customers and a larger share of wallet. Banks no longer have to tell their customers they cannot offer them this product. Second, banks enjoy higher levels of loans with attractive yields, as well as incremental fee income from referred loans. Banks enjoy risk benefits as well, diversifying their portfolios by loan type and geography. Most important, BancAlliance banks receive all of these benefits without having to make any material upfront investment and with minimal ongoing operational costs. Consumer lending is most efficient when done on a large scale basis, and this program allows community banks to mimic this scale without incurring the costs necessary to create it on their own.

Partnering with the Enemy?


3-30-15-Naomi.pngSugar River Bank has a growth problem. Serving a rural area, the $268 million asset bank in Newport, New Hampshire, sits in a town with a population of about 6,500 people. The bank’s management team would like to diversify and do more consumer loans, but there are only so many potential borrowers in the market. So the bank is turning to the Lending Club, a San Francisco-based online marketplace, which is positioning itself both as a partner with and an alternative to traditional banks. Sugar River Bank wants to buy consumer loans generated from Lending Club’s online platform. But are banks such as Sugar River too friendly with the competition?

A Federal Reserve survey found that 20 percent of small businesses applying for credit in the first half of 2014 reported they applied through an online lender. “Things are changing so greatly, I don’t understand [bankers] who don’t want to do partnerships,’’ says Mark Pitkin, Sugar River’s president and CEO.

Sugar River is a member of BancAlliance, a membership organization with more than 200 community banks, which recently signed a deal with Lending Club, giving the banks an opportunity to buy loans or portions of loans nationwide, as well as a chance to co-brand a marketing campaign where Lending Club will underwrite and solicit the banks’ own customers for a loan. Prosper Marketplace, another San Francisco-based online lender, signed a similar deal with Western Independent Bankers, giving the association’s roughly 160 members access to the Prosper Marketplace.

Both deals are for unsecured, fixed-rate installment consumer loans, which are billed as less expensive for the consumer than traditional credit card loans, with rates as low as 6.5 percent for the best borrowers. (Lending Club also offers small business loans, but for now, that’s not a part of the BancAlliance deal.)

Community banks in large part have lost market share for consumer loans to bigger banks during the last few decades, as they can’t compete with the efficiencies enjoyed by the bigger banks. Steven Museles, the general counsel and head of client business for Alliance Partners, the Chevy Chase, Maryland-based asset manager that runs BancAlliance, says the average community bank would have to invest tens if not hundreds of thousands of dollars to scale up a consumer lending business. “We think it’s a significant opportunity for our members,’’ he says. “Many of them would have difficulty putting in place a consumer lending program that could get to any scale.”

According to Ron Suber, president of Prosper, banks don’t want to turn their customers away for consumer loans, and they don’t want to push them into high-interest credit card debt. Partnering with Prosper offers a better alternative for the bank, which receives a 4 percent yield. Borrowers also pay about 4 percent as an origination fee to Prosper and the bank pays Prosper 1 percent of the outstanding balance to service the loan, usually with a three-year term. Customers can apply for a loan from their mobile devices or laptops, or while sitting in a bank’s office. The bank can specify the investment grade for the loans it will buy, such as AA loans, and Prosper categorizes them using data on consumers such as a FICO credit score, payment history and debt to income ratios.

But what are the risks? Fitch Ratings’ Brendan Sheehy, director of financial institutions, thinks the online marketplaces could loosen their underwriting standards to generate additional fees for themselves. In 2013, origination fees made up 88 percent of Lending Club’s total net revenues. And he’s not sure how much visibility community banks really will have into the underwriting models the online marketplaces will use. But he also thinks for now, these types of loans will remain a small part of the typical community bank portfolio. Andrew Deringer, the head of financial institutions for Lending Club, says the Lending Club wouldn’t sacrifice its reputation and goodwill by loosening underwriting standards. “The credibility Lending Club has with investors is paramount to the model,’’ he says. “We only build that credibility by building predictable performance to our investors.”

As far as the possibility that Lending Club could steal customers from banks such as Sugar River and offer them other products, the BancAlliance deal includes a provision to protect the bank’s customers from getting other offers from the Lending Club.