How Banks Can Book Small Commercial Loans and Make a Profit
By Mark Tyburski, President , ILS Advisory Group

Lenders know they are out there - those small commercial real estate loans that can make the difference for growing business owners. They are the kind of loans that can forge a relationship between a lender and a growing business for many years to come. The loans are for approximately $250,000 or less and/or for the refinancing of an existing loan $1 mill ion or less for owner-occupied property.

The problem is that such loans are almost impossible to write and make a profit. The amount of time to book a $250,000 loan to a large degree is about the same as booking one for $2 million. Both require legal support and the attention of a loan officer. Both require appraisal reports, credit reports, flood certifications, and environmental analysis. As a result, it's hard to do these loans at a cost that is relative to their amount. For example, for a $2 million loan, the typical total loan cost, not including points, is $5,000-10,000. That represents .0025 -. 005 percent of the loan. But, take that same $5,000 - $10,000 and put it on $250,000 loan and that is 2-4 percent. Most small businesses can't afford these upfront fees. They make no business sense.

Larger banks have the in-house capabilities and economies of scale that allow them to do these loans at lower costs than the smaller institutions. Smaller banks, on the other hand, have to outsource all their loan documentation making their costs higher.

Let's look at just one part of the loan process where smaller banks are at a disadvantage: the property appraisal. Most large banks have the resources and experts to perform in-house property "evaluations". If not, they have greater leverage with vendors in obtaining evaluation services at more reasonable prices. They can also afford the liability and risk associated with making their own evaluation. Smaller banks typically have neither the expertise nor the resources to do this internally. So, they go outside for "complete" appraisals on most properties to be safe. After all, they can't afford the risk if it's wrong because of the size of their institution. Naturally, this adds significantly to the cost to do the transaction.

So, what's a small bank to do? In the very least, they need to find a vendor with the ability to produce the appraisal report in the most efficient and cost-effective manner. This means the vendor has to be utilizing the most up-to-date technology and the most concise report formats. The vendor also should have the ability to service a large geographic region, the staff to product reports quickly, and the expertise and market knowledge to produce an accurate report. Ideally, they should provide not just the appraisal report, but all of the services needed to close a loan. This allows the institution to achieve economies of scale through "one-stop" shopping. By ordering numerous products at one time, such as appraisal/evaluation, business credit report, flood certification and environmental screen, they can take advantage of multiple product price discounts.

This also makes more sense for the loan officer in a small bank because it offers convenience and saves time. In a smaller institution, it is usually the responsibility of one loan officer to order all these products. Without this "one-stop" shopping, that loan officer is stuck ordering multiple products, making repetitious phone calls and getting various bids, instead of spending time maintaining relationships and prospecting for new business.

The one-stop shopping concept has not been available on the commercial side in the past, but it is today. With it, the commercial real estate loan arena can be good for small banks. They can take advantage of economies of scale that make the loans make sense for them. And, while it may take a little homework up front to find the right outside vendor, the proper decisions can pay off on the bottom line.