Specialty Lending That Strengthens Communities

At first glance, the aviation, dentistry and poultry farming sectors might not seem to have much in common. But those industries, along with dozens of others, are a growing focus for community banks that are looking to gain a foothold in niche lending.

Specialty lending offers significant advantages for both banks and the communities they support. Focusing on a particular niche allows banks to develop deeper expertise and a better understanding of the issues and pain points that customers in a particular industry face, allowing lenders to provide guidance and tailored financing solutions. Niche lending also creates an opportunity for banks to use relationships and expertise to diversify and grow their loan portfolios. 

Candidly, some community banks land in a particular specialty by chance, as they’re pulled along by existing customers. One or two deals may open the door to many more. In other cases, banks take a targeted approach to seek out specific growth sectors and hire key people who can help lead that growth. 

Independent Banker talked with three banks that have developed specialty lending in employee stock ownership plan financing, commercial leases and nonprofit lending to hear how they’re managing the challenges and opportunities as they continue to grow their niche lending business.

For many companies, equipment is critical to keep operations running. First Guaranty Bank in Hammond, Louisiana, finances heavy commercial equipment and manufacturing lines through equipment financing loans and commercial leases—a niche that has contributed to the bank’s growth. 

First Guaranty entered the commercial lease space about 10 years ago when it bought a pool of commercial leases from another bank that was looking to exit the business. Today, its commercial leases represent roughly 8% of the $4 billion-asset bank’s overall loan portfolio. 

“It’s a growth industry, and it’s given us a nice niche to focus on long term,” says Randy Vicknair, chief lending officer at First Guaranty Bank.

Combining leasing and lending

The underwriting on a commercial lease is very similar to the underwriting for a traditional commercial and industrial loan. 

“The difference is that you have to take a deeper look at your collateral with the lease structure, because the bank kind of takes ownership of that collateral and leases it back to the party,” says Vicknair. 

Unlike equipment financing, commercial leases generate monthly rent payments instead of note payments, often at a higher yield. A commercial lease also might require more analysis depending on the type of lease. A capital lease will have a dollar payout per dollar buyout, which is similar to equipment financing on the loan side. An operating lease is typically structured with a residual balance, which usually benefits the customer by allowing a lower monthly rent payment. 

The offset is that at the end of the operating lease term, such as three or five years, the customer will have some remaining residual balance. The customer can either pay the balance off in full or structure extension payments on a set schedule until that residual balance is paid off.

Stepping outside its footprint

First Guaranty recognized the opportunity to go outside of its geographic market to generate additional growth in its commercial lease business. The community bank will consider deals across the U.S. where there is an underlying strength that lowers the risk, such as higher credit quality.

“It’s been a great opportunity for us to obtain new clients, because sometimes their senior lender has covenants that restrict them from doing different financing arrangements,” notes Vicknair. Commercial leases also provide cross-sell opportunities to existing clients, such as providing another option in situations where an equipment lease might not work.

First Guaranty is one of the few banks of its size competing for commercial lease deals in a market that is dominated by big banks, privately held commercial lease companies and equipment finance companies. 

One of the ways that the community bank distinguishes itself in a competitive market is through its ability to move quickly to make decisions and fund deals. 

“These companies typically have a need that’s identified, and they need to be able to pursue that piece of equipment, whether it’s for expansion or the need to replace a piece of equipment that’s broken down,” says Vicknair. “So, speed is typically the most important factor.” It’s also important to have a team with the knowledge and experience to handle these types of transactions, he adds.

Supporting nonprofits aligns with many community banks’ mission to support organizations in their local communities, ranging from art and cultural bodies to groups that provide food and shelter to people in need. But banking nonprofits is also big business, considering the more than 1.8 million registered 501(c) organizations across the U.S.

“The big purpose of what we do here, and what we pride ourselves on, is giving back to the community and in banking with a purpose,” says Reine Hamilton, senior vice president and commercial banking manager at Bell Bank in Fargo, North Dakota. That underlying goal was the impetus for Bell Bank to create a specific focus on supporting the nonprofit sector.

Giving and receiving support

Nonprofits are now a large part of the community that $13 billion‑asset Bell Bank serves across its commercial banking footprint in North Dakota, Minnesota and Arizona. 

“There are so many nonprofits within each of our markets that are the fabric of our communities,” says Hamilton. 

In Arizona alone, nonprofits represent 8% of state GDP and employ more than 200,000 people. “We also recognize that if those organizations are not supported by their financial institution, they’re going to be challenged in supporting our community,” says Hamilton. “So, it’s part of our social responsibility at Bell to ensure that we’re providing that level of attention to them and providing that gap that sometimes the public and the private sector leaves behind.” 

Nonprofits face challenges such as irregular funding cycles or relying on time-sensitive grants. Bell Bank aims to tailor its services and products to align with nonprofits’ specific needs, help with their pain points and provide flexibility for mission-driven organizations. 

Many nonprofits are facing bigger funding challenges in the wake of federal budget cuts. According to research from Arizona State University’s Lodestar Center, nearly half (47%) of the Arizona organizations that receive either direct federal funding or pass-through funding say they have experienced delays in payments or the cancellation of grants or contracts following federal cutbacks. 

Rural nonprofit organizations are especially reliant on this funding; 42% of the rural organizations surveyed report that they receive more than half their funding from federal sources.

Bell Bank is helping its nonprofit clients’ financial planning in cases where organizations may have endowments or other resources that they can tap into, as well as presenting solutions to help bridge gaps that may arise. “Diversification of funding is certainly key in helping them navigate through the uncertainty,” says Hamilton.

Navigating revenue challenges

The number one hurdle in banking nonprofits is the unpredictability of their revenue streams, which can complicate any potential lending situation or financial planning. “We’re well aware of that, and that’s just the nature of the business and the cycle that they’re in,” says Hamilton. 

Bell Bank addresses that by staying informed of any changes within an organization, as well as keeping current on regulatory changes or requirements coming from a state or federal level that a nonprofit customer has to abide by. It’s also important to have the right team in place, one that is educated on different niche markets and challenges within the nonprofit sector, Hamilton adds.

The success of a nonprofit isn’t measured by its profit margins but by its social impact in the community, Hamilton notes. As such, it’s important for a banking partner to dig in and better understand an organization from all angles. Some of the key questions that Bell Bank’s team asks nonprofits include:

• Who is on the nonprofit’s board?

• What is the nonprofit aiming to do in the community?

• How is it accomplishing that?

• How is it navigating its cash flow?

• Are there donor restrictions on some of the funding it receives?

• What are the compliance or grant requirements it must abide by?

“We spend a lot of our time with boots on the ground getting to know these organizations, getting to know their pain points and also what matters to them the most,” says Hamilton. 

That understanding of the nonprofit cash flow cycle also helps Bell Bank’s team be of value to its clients, such as modifying banking products to help them with their fundraising cycles or bridge a funding gap that may emerge due to changes in government or philanthropic funding programs. “We stay informed to help guide those conversations, and we make sure that we’re proactive,” Hamilton adds.

As a senior vice president, commercial relationship manager and  ESOP specialist at $2.5 billion-asset Georgia Banking Company in Atlanta, Holly Sims has seen numerous examples of the positive community impact that stems from an employee stock ownership plan (ESOP). Such transactions often allow a company to keep operating in the hands of its employees, meaning that the business and jobs stay in a community. 

ESOP lending often comes into play when a business owner is looking to retire or exit the business. The owner sells the company to a trust, which holds the stock of that company and gives those shares to employees annually as part of their compensation or benefits. 

ESOPs are recognized by the IRS as qualified retirement plans. Employees become stakeholders in the company, and when an employee leaves or retires, the company repurchases the shares. “If you sell your company for $45 million, you’re probably going to want some cash and not just a whole bunch of notes from the company,” says Sims. 

Georgia Banking Company provides a loan—typically based on a multiple of the client company’s longevity and earnings before interest, taxes, depreciation and amortization—that permits the selling party to convert a portion of their seller notes to cash. 

Generating stable, repeat business

One advantage of ESOP lending for community banks is that the loans tend to be very stable. The default rate of an ESOP loan is lower than that of a standard C&I loan and about six times less likely to default than a private equity transaction, according to Sims. ESOP lending also generates repeat business. 

“We are not [refinancing] the entire portfolio of seller notes. We do about a third, and then when those get paid down, we do it again. When those get paid down, we do it again,” says Sims. “It’s almost like having an annuity, and it builds a really good-quality commercial portfolio for the bank as well, because when you help a company do something like this, they tend to be a very loyal client.”

For community banks that might be considering engaging in ESOP lending, it is a heavy lift, says Sims. In addition to the complexities in structuring transactions and tax considerations, the ESOP marketplace is small and tightly knit. She advises that it’s important to hire someone who is experienced and has contacts in the industry. 

Another important component is good credit partners. “We need to know what appropriate leverage metrics to use, and what levers to pull if we see a company’s cash flow start to get a little sideways,” Sims adds.