How to TiptoeHow to Tiptoe

(Rather Than Stumble)(Rather Than Stumble)

into Member into Member Business Business ServicesServices

Jeff StoneJeff StoneEVP, Member Business EVP, Member Business ServicesServicesNorth Island Credit UnionNorth Island Credit Unionjstone@myisland.com

Management wants to pursue Management wants to pursue Member Business Lending (MBL) and Member Business Lending (MBL) and Deposit ServicesDeposit Services

How should the Board of Directors How should the Board of Directors respond and what kind of due respond and what kind of due diligence and preparation should diligence and preparation should they be looking for???they be looking for???

What is a Board of Directors to What is a Board of Directors to Do?Do?

In short, what questions should you be In short, what questions should you be asking?asking?

Does Management Have a Does Management Have a Business Plan?Business Plan?

Buy Loans Only (In-Participations)Buy Loans Only (In-Participations) Originate Commercial Real Estate Loans Originate Commercial Real Estate Loans

OnlyOnly

-- -- OROR Build a Full Member Business Services Build a Full Member Business Services

Infrastructure (including deposits)—and if Infrastructure (including deposits)—and if so, have they identified a so, have they identified a nicheniche to serve? to serve?

Have they determined what your credit Have they determined what your credit union will do with the MBL Product?union will do with the MBL Product?

Early on Board EducationEarly on Board Education

Do you have Enough Information to:Do you have Enough Information to: Understand the Paradigm Shift from Consumer Lending? Understand the Risks of these New Products? Determine if your Credit Union has the Resources to pull

off the plan over the next 2-4 years? Decide: is the right move in today’s Economic

Conditions?

Has Management Explained the Details and Sought Has Management Explained the Details and Sought out Your Input?out Your Input? Have you Determined the Level and Process for Ongoing

Board Oversight and Involvement?

Bottom Line: Do you “Buy In” to the Concept?Bottom Line: Do you “Buy In” to the Concept?

PoliciesPolicies

MBL Policy must be in place Before you do or buy MBL Policy must be in place Before you do or buy your first loanyour first loan Must Conform to the Requirements of 12 CFR Section 723.6

Should Quantify your Potential Exposure in Terms of Percentage of Net Worth

If your Credit Union will buy and/or sell Loan If your Credit Union will buy and/or sell Loan Participations, the NCUA also requires that you have Participations, the NCUA also requires that you have a Separate Participation Policya Separate Participation Policy

Policies vs ProceduresPolicies vs Procedures

The NCUA has recently indicated that The NCUA has recently indicated that ProceduresProcedures should should also be approved by the Boardalso be approved by the Board

Continuous Monitoring via:Continuous Monitoring via:

Policy vs. Regulatory Loan to One Borrower Policy vs. Regulatory Loan to One Borrower (LTOB) Limits(LTOB) Limits The Board may wish to set an Internal The Board may wish to set an Internal PolicyPolicy Limit Limit

that is Lower than your that is Lower than your RegulatoryRegulatory Limit (15% of Limit (15% of Net Worth)Net Worth)

All All PolicyPolicy Exceptions should require Board Exceptions should require Board Approval Approval PriorPrior to Loan Funding to Loan Funding

Quarterly Reports on All Aspects of the Quarterly Reports on All Aspects of the ProgramProgram Especially on relationship to MBL CAP and Especially on relationship to MBL CAP and

Procedural ExceptionsProcedural Exceptions

Which Road to Take?Which Road to Take?

What steps should your Credit Union What steps should your Credit Union take to get to the planned objective?take to get to the planned objective?

This Presentation will use North This Presentation will use North Island as an ExampleIsland as an Example Because we lingered at many of the Because we lingered at many of the

possible stopping points as we possible stopping points as we wandered down our Roadwandered down our Road

Also, there are several CUSOs that Also, there are several CUSOs that have been created to assist you in have been created to assist you in this processthis process

The North Island Approach:The North Island Approach: What We Will What We Will CoverCover

Why Do Member Business Services?Why Do Member Business Services?

The How and What of North Island’s The How and What of North Island’s ProgramProgram

Risk Mitigation and Board Oversight Risk Mitigation and Board Oversight ToolsTools

Why North Island Why North Island Went Down this RoadWent Down this Road

Why North Why North Island Went Island Went Down this Down this

RoadRoad

Member Business Lending:Member Business Lending:The Starting PointThe Starting Point

ALCO Asset Diversification ALCO Asset Diversification StrategyStrategy

Enhanced Profitability—Enhanced Profitability—Alternative “Investment” StrategyAlternative “Investment” Strategy—but these are all Loans and —but these are all Loans and notnot InvestmentsInvestments

A Means to Build Core DepositsA Means to Build Core Deposits

Asset DiversificationAsset Diversification

New Loan TypesNew Loan Types Commercial Real Estate (CRE) Loans—to Commercial Real Estate (CRE) Loans—to

StartStart SBA 504 Loans SBA 504 Loans Secured & Unsecured Lines of CreditSecured & Unsecured Lines of Credit Equipment & Auto Term Loans Equipment & Auto Term Loans SBA 7a and State Government SBA 7a and State Government

Guaranteed LoansGuaranteed Loans

Portfolio YieldPortfolio Yield

4-5 years ago CRE Loan yields 4-5 years ago CRE Loan yields were 200 bps over the portfolio were 200 bps over the portfolio averageaverage

Its still over average, even with Its still over average, even with the current tighter margins and the current tighter margins and intense competition, but now the intense competition, but now the bump is down to 60 bpsbump is down to 60 bpsHowever, Loan Fees and Servicing However, Loan Fees and Servicing Income add greatly to total Income add greatly to total incomeincome

Ability to Attract Low Cost Ability to Attract Low Cost DepositsDeposits

Conversion to a Community Charter HelpsConversion to a Community Charter Helps

Bank Consolidations = CU OpportunitiesBank Consolidations = CU Opportunities

Displaced Bankers Are Source of Displaced Bankers Are Source of

Experienced StaffExperienced Staff

CU Service Levels Get ResultsCU Service Levels Get Results

Can Outsource other Fee Driven ServicesCan Outsource other Fee Driven Services

HowHow We WeGot Got

Started: Started:

The Gradual ApproachThe Gradual Approach

The Progression

1) Six Month Due Diligence Process

2) Built Portfolio & Infrastructure by Buying Loan Participations

3) Established Wholesale Lending Pipeline by Establishing Broker Network

4) Managed the CAP by Selling Participations

5) Created Relationships (and Core Deposits) with Direct Lending through Branches

The Due Diligence ProcessThe Due Diligence Process

Spent 6 Months on a Consulting Contract Spent 6 Months on a Consulting Contract to Determine Feasibilityto Determine Feasibility

Market NicheMarket Niche Created by Bank Mergers Created by Bank Mergers

Focus Groups to Ask Existing Business Like Focus Groups to Ask Existing Business Like Members and Previous Clients what they Members and Previous Clients what they Valued Most.Valued Most.

Step by Step Plan to Create Products & Step by Step Plan to Create Products & ServicesServices

Cost AnalysisCost Analysis

Loan Participation Loan Participation PurchasesPurchases

No Need to Hire Staff at the OutsetNo Need to Hire Staff at the Outset

Due Diligence Can Be Performed by:Due Diligence Can Be Performed by: A Consultant A Consultant OROR Another Credit Union/CUSO Another Credit Union/CUSO

with the Required Expertisewith the Required Expertise

Your Credit Union Has to Make Your Credit Union Has to Make Final DecisionFinal Decision on All Loanson All Loans

Loans Typically will Fit on Your Existing Loans Typically will Fit on Your Existing Real Estate SystemReal Estate System

Low Cost of Low Cost of EntryEntry into a New Line of into a New Line of Business:Business:

Loan Participation Loan Participation SalesSales

Provide Full Service to MembersProvide Full Service to Members

Acts as a Tool to Deal with LTOB Acts as a Tool to Deal with LTOB

LimitationsLimitations

Mitigates Impact of MBL CAPMitigates Impact of MBL CAP

156% Without Participations156% Without Participations

Increases Loan YieldIncreases Loan Yield

Prepayment Penalties and Servicing FeesPrepayment Penalties and Servicing Fees

Accounting Benefits of Loan Accounting Benefits of Loan Participations SalesParticipations Sales

The Fee Income Associated with the Sold The Fee Income Associated with the Sold Portion Goes to the Bottom LinePortion Goes to the Bottom Line The Remainder Needs to be Amortized The Remainder Needs to be Amortized

Seller Collects a Servicing FeeSeller Collects a Servicing Fee The Servicing Fee is Capitalized—It Too The Servicing Fee is Capitalized—It Too

Goes to the Bottom Line Goes to the Bottom Line The Expense is then Amortized over the The Expense is then Amortized over the

Expected Life of the LoanExpected Life of the Loan Prepayment Exposure—Primary Reason for Prepayment Exposure—Primary Reason for

PenaltiesPenalties

What Came What Came Next?Next?

The Jump to Business ServicesThe Jump to Business Services

Add Services as Members Request ThemAdd Services as Members Request Them Limited Suite of ProductsLimited Suite of Products

Like North Island—Move Quickly to Full Like North Island—Move Quickly to Full Product LineProduct Line Requires Willingness to Make Expenditures for:Requires Willingness to Make Expenditures for:

Experienced StaffExperienced Staff Powerful Host System—with Open Architecture, Powerful Host System—with Open Architecture, oror Bolt On MiddlewareBolt On Middleware

Two Approaches—Depends on Your Market & Two Approaches—Depends on Your Market & Comfort LevelComfort Level —Prepare a Business Plan and —Prepare a Business Plan and Choose:Choose:

Our “Lucky” BreaksOur “Lucky” Breaks

Changed Charters to CommunityChanged Charters to Community Businesses themselves could now joinBusinesses themselves could now join

Host System ConversionHost System Conversion Old Legacy System was going out of Old Legacy System was going out of

serviceservice New system handles both consumer and New system handles both consumer and

business transactionsbusiness transactions Costly—but the income from several years Costly—but the income from several years

of CRE Loan production helped pay the wayof CRE Loan production helped pay the way Bank Mergers made Staff AvailableBank Mergers made Staff Available

InfrastructurInfrastructuree

OverviewOverview

Branch Staff’s RoleBranch Staff’s Role

TrainingTraining a Must a Must We Have Our Own Six Week We Have Our Own Six Week OmegaOmega

Based MBS Training Program for Based MBS Training Program for Branch Managers and othersBranch Managers and others

Incentives and Sales CultureIncentives and Sales Culture New Accounts TrainingNew Accounts Training Internal Website Provides the ToolsInternal Website Provides the Tools

BranchesBranches

Business Deposits Basic, Classic and Analyzed Checking Savings, Money Market & CDs

Loans Overdraft Lines of Credit Approved at

Branch Through Credit Scoring Fed Tax Deposits

Branches with Business Branches with Business Services’ SupportServices’ Support

Deposit Services Business On-line Banking ACH Origination Sweep (on balance sheet) Zero Balance Accounts

What did you say???

Business Loans Business Auto Loans Unsecured LOC’s Business Debit Cards

Through Business ServicesThrough Business Services

Business Loans

–Commercial Real Estate Loans

(Wholesale/ Direct and Participations)

–Secured & Unsecured Lines

–Government Guaranteed Loans

Through Vendors

– Payroll– Merchant Credit Card– Business Credit Cards– Courier & Armored Car– Lockbox

– Processing of payments from our Members’ customers

– Equipment Leasing– Letters of Credit– Insurance & Investment Services

- Referred to Investment Dept (former CUSO)

Vendor Due Diligence Vendor Due Diligence

Several of the Vendors were known Several of the Vendors were known to us from our Previous Livesto us from our Previous Lives

Others We Checked Out via Others We Checked Out via References and Test CasesReferences and Test Cases

On others, we used Multiple VendorsOn others, we used Multiple Vendors And in one case (Letters of Credit) And in one case (Letters of Credit)

we use a Statewide Bankwe use a Statewide Bank Regulators want the credit union to Regulators want the credit union to

know who they are dealing withknow who they are dealing with

Employee Benefits 401K and Pension Cafeteria Group Insurance

Medical Term Life Auto Insurance Long-Term Care

Educational Workshops

Insurance & Investment Services Insurance & Investment Services Dept. Cross SalesDept. Cross Sales

Web Based ComponentsWeb Based Components

www.MyIsland.com - Public - Public www.MyIsland.com/brokers Public Public www.MyIsland.com/partners –Public –Public Islandnet – Corporate IntranetIslandnet – Corporate Intranet

myisland.commyisland.com (ConsumerConsumer)

myisland.commyisland.com (BusinessBusiness)

myisland/brokersmyisland/brokers

myisland/myisland/partnerspartners

Corporate IntranetCorporate Intranet

Intranet Intranet cont’dcont’d

Phase III IntroductionsPhase III Introductions

Phase III Introductions – Account Analysis

Enhancements– Off Balance Sheet Sweep

(future)– Positive Pay (on the way)– Third Party CD’s (done)– Remote Deposit Capture (this

year)

Other Other

ConsideratioConsiderationsns

Staffing—The Relationship Staffing—The Relationship ManagersManagers

Former BankersFormer Bankers Business Bankers from a Community Business Bankers from a Community

BankBank Easier Fit in Credit Union CultureEasier Fit in Credit Union Culture Plus Usually Well RoundedPlus Usually Well Rounded Often More Costly than Consumer LendersOften More Costly than Consumer Lenders Becoming Becoming Harder to FindHarder to Find

Especially with Required Experience—7 to Especially with Required Experience—7 to 10 years10 years

Bank Mergers often make talent availableBank Mergers often make talent available

Training/SuccessionTraining/Succession Marketing SupportMarketing Support

UnderwritingUnderwriting

More Intensive than Consumer LoansMore Intensive than Consumer Loans Financial Statement AnalysisFinancial Statement Analysis

How the Business is performing in relationship How the Business is performing in relationship to its Peers and your Underwriting to its Peers and your Underwriting RequirementsRequirements

Tax AnalysisTax Analysis Evaluating the Business Owner’s Tax Returns is Evaluating the Business Owner’s Tax Returns is

quite Important—since most of us are Lending quite Important—since most of us are Lending to Small Businesses with One or Two Ownersto Small Businesses with One or Two Owners

In other words, the financial capacity of the In other words, the financial capacity of the Business and its Owners are linked togetherBusiness and its Owners are linked together

Credit ScoringCredit Scoring

Cost of System vs. Credit AnalystCost of System vs. Credit Analyst Determine Maximum Loan Size to Determine Maximum Loan Size to

Credit ScoreCredit Score Determine Loss Tolerance—Determine Loss Tolerance—

especially in current economyespecially in current economy Look for Single Data Entry Look for Single Data Entry

CapabilitiesCapabilities Can It Interface with Doc Prep and Can It Interface with Doc Prep and

Host?Host?

Loan DocumentationLoan Documentation

Look for Recognized SystemLook for Recognized System Multiple options availableMultiple options available

Again—Be aware of systems ability to Again—Be aware of systems ability to interface with existing programs!!interface with existing programs!!

Appropriate Appropriate ControlsControls

Quality Control AuditQuality Control Audit

Need Independent Person Need Independent Person Reviewing Reviewing NewNew Loan Files Loan Files

Ours comes in once a monthOurs comes in once a month

Selects a Sampling of loans to reviewSelects a Sampling of loans to review

Does a Comprehensive Report on both Does a Comprehensive Report on both technical issues and credit qualitytechnical issues and credit quality

Report sent to EVP Risk ManagementReport sent to EVP Risk Management

Copy to Business Services Dept. Head Copy to Business Services Dept. Head for a Responsefor a Response

Annual Loan ReviewsAnnual Loan Reviews

Commercial Real Estate LoansCommercial Real Estate Loans Annually we Inspect the Properties for Each Annually we Inspect the Properties for Each

Participated LoanParticipated Loan

We Obtain Updated Rent Rolls and P&L We Obtain Updated Rent Rolls and P&L Statements on the PropertyStatements on the Property

We request Full Financials if Screen Reveals We request Full Financials if Screen Reveals any Issues or Covenant Violationsany Issues or Covenant Violations

Business LoansBusiness Loans Site Visits, Covenant Tracking and Financial Site Visits, Covenant Tracking and Financial

Updates on Business LoansUpdates on Business Loans

We run a Negative Screen Credit Report on the We run a Negative Screen Credit Report on the PrincipalsPrincipals

Asset Quality MonitoringAsset Quality Monitoring

MonthlyMonthly, Our Credit Administrator prepares , Our Credit Administrator prepares a Report to our EVP Risk Administration, who a Report to our EVP Risk Administration, who is in charge of the Loan Loss Allocation, is in charge of the Loan Loss Allocation, regarding the Status (and Workout Progress) regarding the Status (and Workout Progress) of all our Classified Member Business Loansof all our Classified Member Business Loans

Stay on top of Problem Loans!!!!!Stay on top of Problem Loans!!!!!

Quarterly Quarterly Board Board

ReportingReporting

What We ReportWhat We Report

Year To Date Production ResultsYear To Date Production Results LoansLoans DepositsDeposits Fee IncomeFee Income

Commitments over $3MM with Procedural Commitments over $3MM with Procedural ExceptionsExceptions Attach Both the Exception and Mitigant Attach Both the Exception and Mitigant

Discussion from the Loan MemoDiscussion from the Loan Memo Delinquent Loan StatusDelinquent Loan Status

What We Report—cont.What We Report—cont.

The Concentration ReportsThe Concentration Reports The CRE Portfolio BreakdownsThe CRE Portfolio Breakdowns

The NAICS Code BreakdownThe NAICS Code Breakdown

The Stress Test ResultsThe Stress Test Results

Industry TrendsIndustry Trends Our Evaluation of What is Happening in Our Evaluation of What is Happening in

Our Market—Price Wars, CAP Rates, etc.Our Market—Price Wars, CAP Rates, etc.

Articles on the Status of the Market for the Articles on the Status of the Market for the Various Property TypesVarious Property Types

PortfolioPortfolio

ConcentratioConcentrationn

MonitoringMonitoring

Commercial Real Estate Commercial Real Estate ConcentrationsConcentrations

Dollars by Zip CodeDollars by Zip CodeOther919019190291910919119191491932919419195091977920089201492020920219202492025920269202892029920369204092054920579206492067920719207592084921019210292103921049210592107921089210992110921119211492115921169211892120921219212292123921289213992154921739250592673

Commercial Loan DistributionCommercial Loan Distribution

NAICS Codes for All Business NAICS Codes for All Business LoansLoans

Sample Sample Industry Industry ReportReport

So Why Go Through All This?So Why Go Through All This?

Serve your Members!!! Serve your Members!!! Many want these productsMany want these products Usually depends on Field of MembershipUsually depends on Field of Membership

Grow the Credit UnionGrow the Credit Union Lower your Cost of Funds (the Core Lower your Cost of Funds (the Core

Deposits) andDeposits) and Diversify your Asset BaseDiversify your Asset Base

QuestionsQuestions