Current Benefits of Banking Legal Cannabis Businesses

Written by

While historically viewed as “strange bedfellows,” more financial institutions are offering services to cannabis businesses across the country. Though their worlds may seemingly look quite different, both are highly regulated, cash-intensive industries that can solve challenges for each other.

From the cannabis operator perspective, the benefits of a strong banking partner are straightforward. This relationship offers a safe place to store the intake from cash-heavy sales, a way to make tax and other payments electronically and the ability to facilitate direct deposits for employees. Additionally, other opportunities for banks include loan opportunities and additional benefits such as partnerships with human resources/payroll, payments and insurance are becoming more common.

The benefits for financial institutions, however, are ever-evolving. Up until this year, banks primarily looked at cannabis customers as a service relationship. “I’ll take care of your business needs, and you’ll pay me service fees for doing that.” But what we at Green Check have seen over the past several months is that these relationships are starting to look far more traditional. That means financial institutions that are willing to bank, and truly work with, the cannabis businesses in their market will encounter a far bigger opportunity.

Let’s start with low cost deposits. The federal funds rate is up. Many financial institutions are staving off the certificate of deposit pricing wars by paying higher annual percentage yields (APYs), and the overall cost of funds is inching up daily. The standard play here is often to seek out commercial customers. When we look at cannabis deposits in that light, the cost of funds is most often less than 1%. That could certainly help in those asset-liability committee meetings.

Next we have fee revenue. We’ve all had that conversation around the boardroom table about replacing overdraft fee income with other options to keep noninterest income from plummeting. Opening up the traditional suite of commercial services to the cannabis industry gives a financial institution a fresh new market segment to approach, along with the additional business service fees from those new opportunities.

And what about lending? An increasing amount of our financial institution clients have begun lending to the cannabis industry. It’s often one of the first questions that cannabis operators ask when seeking out a new banking relationship, making it quickly a table stakes option. One way for banks to step lightly into lending is to begin with the smaller lending opportunities such as unsecured line of credit facilities, or even equipment financing: loans that are less than $1 million, with less complex collateralization. Other financial institutions that aren’t able to take on the larger real estate loans and build-out financing can be a participant with a lead bank who has more experience in this area.

Far from strange bedfellows, these two industries can work together synergistically. In this current high rate environment, they need each other now more than ever. However, it’s essential that any bank wanting to offer services to this complex, rapidly expanding industry seeks proper guidance. Seeking experienced help from a reliable cannabis banking firm should be your bank’s first step in reaping the benefits of working with legal cannabis.

Banks Are Letting Deposits Run Off, but for How Long?

Written by

In September, the CEO of Fifth Third Bancorp, Tim Spence, said something at the Barclays investor conference that might have seemed astonishing at another time. The Cincinnati, Ohio-based bank was letting $10 billion simply roll off its balance sheet in the first half of the year, an amount the CEO described as “surge” deposits.

In an age when banks are awash in liquidity, many of them are happily waving goodbye to some amount of their deposits, which appear as a liability on the balance sheet, not an asset.
Like Fifth Third, banks overall have been slow to raise interest rates on deposits, feeling no urgency to keep up with the Federal Reserve’s substantial interest rate hikes this year.

Evidence suggests that deposits have begun to leave the banking system. That may not be such a bad thing. But bank management teams should carefully assess their deposit strategies as interest rates rise, ensuring they don’t become complacent after years of near zero interest rates. “Many bankers lack meaningful, what I would call meaningful, game plans,” says Matt Pieniazek, president and CEO of Darling Consulting Group, which advises banks on balance sheet management.

In recent years, that critique hasn’t been an issue — but that could change. As of the week of Oct. 5, deposits in the banking system dipped to $17.77 trillion, down from $18.07 trillion in August, according to the Federal Reserve. Through the first half of the year, mid-sized banks with $10 billion to $60 billion in assets lost 2% to 3% of their deposits, according to Fitch Ratings Associate Director Brian Thies.

This doesn’t worry Fitch Ratings’ Managing Director for the North American banking team, Christopher Wolfe. Banks added about $9.2 trillion in deposits during the last decade, according to FDIC data. Wolfe characterizes these liquidity levels as “historic.”

“So far, we haven’t seen drastic changes in liquidity,” he says.

In other words, there’s still a lot of wiggle room for most banks. Banks can use deposits to fund loan growth, but so far, deposits far exceed loans. Loan-to-deposit ratios have been falling, reaching a historic low in recent years. The 20-year average loan-to-deposit ratio was 81%, according to Fitch Ratings. In the second quarter of 2022, it was 59.26%, according to the Federal Deposit Insurance Corp.

In September, the Federal Reserve’s Board of Governors enacted its third consecutive 75 basis point hike to fight raging inflation — bringing the fed funds target rate range to 3% to 3.25%. Banks showed no signs of matching the aggressive rate hikes. The median deposit betas, a figure that shows how sensitive banks are to rising rates, came in at 2% through June of this year, according to Thies. That’s a good thing: The longer banks can hold off on raising deposit rates while variable rate loans rise, the more profitable they become.

But competitors to traditional brick-and-mortar banks, such as online banks and broker-dealers, have been raising rates to attract deposits, Pieniazek says. Many depositors also have figured out they can get a short-term Treasury bill with a yield of about 4%. “You’re starting to see broker-dealers and money management firms … promot[e] insured CDs with 4% [rates],” he says. “The delta between what banks are paying on deposits and what’s available in the market is the widest in modern banking history.”

The question for management teams is how long will this trend last? The industry has enjoyed a steady increase in noninterest-bearing deposits over the years, which has allowed them to lower their overall funding costs. In the fourth quarter of 2019, just 13.7% of deposits were noninterest bearing; that rose to 25.8% in the second quarter of 2021, according to Fitch. There’s a certain amount of money sitting in bank coffers that hasn’t left to chase higher-yielding investments because few alternatives existed. How much of that money could leave the bank’s coffers, and when?

Pieniazek encourages bank boards and management teams to discuss how much in deposits the bank is willing to lose. And if the bank starts to see more loss than that, what’s Plan B? These aren’t easy questions to answer. “Why would you want to fly blind and see what happens?” Pieniazek asks.

What sort of deposits is the bank willing to lose? What’s the strategy for keeping core deposits, the industry term for “sticky” money that likely won’t leave the bank chasing rates? Pieniazek suggests analyzing past data to see what happened when interest rates rose and making some predictions based on that. How long will the excess liquidity stick around? Will it be a few months? A few years? He also suggests keeping track of important, large deposit relationships and deciding in what circumstances the bank will raise rates to keep those funds. And what should tellers and other bank employees say when customers start demanding higher rates?

For its part, Fifth Third has been working hard in recent years to ensure it has a solid base of core deposits and a disciplined pricing strategy that will keep rising rates from leading to drastically higher funding costs. It’s been a long time since banking has been in this predicament. It’s anyone’s guess what happens next.

Giving Small Business Borrowers ’True’ Credit

Written by


iStock_77738245_MEDIUM.jpg

Small business owners and entrepreneurs are the engine that fuel the global economy. Lending to small businesses has been the heartbeat of the over 5,500 community banks, and it’s also how many of the nations largest banks have prospered.

Yet the market for these loans has become commoditized—or as highly accomplished venture capitalist Marc Andreessen has said, have been “eaten by software.”Why? Because banks still treat small businesses and entrepreneurs like they are individuals applying for a personal loan and not a commercial entity with real economic value.

The problem is the current business data and credit scoring infrastructure that most banks use to underwrite loans was not made for the entrepreneur. It was made for the consumer and does not acknowledge the value of the actual business itself to the entrepreneur.

When entrepreneurs go to a bank for a loan, they are always asked two questions.

What is their credit score?

What is their current income or salary?

Simple credit scoring and current income verification is not enough as it does not fully value the entrepreneur and the businesses’ capacity.

Seventy percent of a business owner’s net worth is tied up in their business, but few banks look at anything beyond the value of the real estate, their credit score and their current income. Sixty-seven percent of all private companies are funded at levels that are actually less than they should be because the value of the underlying business has historically been overlooked.

This traditional approach to small business lending is out of date. Today, because of technology and an infinite amount of data, business owners can plug in information about their company and match it against similar businesses to find out what their business is worth, and then leverage that data for loans, insurance coverage or other financial planning matters. Banks like Univest Corp., insurance companies like Penn Mutual and credit bureaus like Equifax and Experian are starting to use and offer online databases to measure a business’ value not just for loans, but for financial planning and risk scoring.

If you are bank, take advantage of new advancements in big data and apply them to your actual core business. Focus your efforts on what used to be your bread-and-butter customer—the small business owner. But be aware that today’s entrepreneurs know that the lending process has now become democratized and they are only a browser away from a better deal. Change the game. Go further. Inspire the next great wave in lending by giving entrepreneurs and small business owners true credit.