Welcome to Breaking Banks, the number one global fintech radio show and podcast. I’m Brett King. And I’m Jason Henricks.

Every week since 2013, we explore the personalities, startups, innovators, and industry players driving disruption in financial services. From incumbents to unicorns and from cutting edge technology to the people using it to help create a more innovative, inclusive, and healthy financial future. I’m J.P. Nichols, and this is Breaking Banks.

Deposits are the aqua vitae of banking, the water of life. The very core of the traditional banking business model is gathering deposits at no to low cost and lending the money back out at higher rates. Bankers used to reference the 3-6-3 rule, bring in deposits at 3%, make loans at 6%, and be out on the golf course by 3 p.m. Money is the primary raw material in the business of banking.

The difference between what financial institutions pay for that raw material is subtracted from what they earn from lending it out right at the very top of their income statements. That difference is net interest income, and it is the largest component of earnings for virtually every bank, as much as 95% or more for some. Expressed as a ratio, the net interest margin, or NIM, is a key metric in measuring bank performance, and it’s been under considerable pressure lately.

The traditional levers one could use to improve net interest margin, or NIM, have been trying to lower deposit rates and raise loan rates and hope you don’t lose too much in volume. But as the business has become more complex, so have the tools and the strategy to reduce that pressure. Today we’re going to get into some of the hidden levers that banks are using to add non-rate value and reduce the pressure on NIM.

In particular, we’re going to focus today on SBA lending as one of them. How new approaches and new technologies expanding the market for banks large and small, and also for fintechs, and how the secondary market is helping to improve liquidity and improve NIM. Joining me today are Steve Tanzer and Joel Updegraff, both managing directors at Breen Capital.

Well Steve, maybe we’ll start with you, and you have a broad perspective on the banking business and yet a unique one. So maybe you want to describe a little bit about your perspective and where you sit in the ecosystem, but what does all this mean to you as you’ve looked at the trends in NIM over the past couple of decades? Well thanks, JP, it’s great to be here. The perspective from which I come from in banking and specifically debt capital markets and the government guaranteed and SBA loan space is somewhat of a unique lens as it relates to how financial institutions can increase incremental NIM.

And the SBA product and other government loan programs that have a robust secondary market create a way and offer a way for banks to make these loans, get the liquidity to continue to make more loans, but also retain a servicing interest cash flow on the portion that they sell that all adds incrementally to that NIM that we’re talking about today. In addition to pretty healthy profits from the premiums that the secondary market pays for these loans. Well I want to dig into that a little bit, but let’s keep the lens a little high for right now and just talk about, as you think about trends, as you’re looking at banks, as you’re working with banks, looking at their balance sheet and their income statements, what are some of the key challenges that you’re seeing and what are some of the leading banks, again at a high level, what are some of the tactics that you’re seeing that are working to help improve the situation? Well the landscape of how deal flow is sourced, how credit is deployed, how opportunities are presented to banks continues to shift very much from the old traditional way of sourcing deal flow from within the community.

Even the smaller community focused financial institutions are going much broader, have national lending platforms that they are utilizing, either partnering with FinTech or FinTech Lite platforms that can bring them deal flow and they can add assets to the balance sheet while having more nimble and more efficient pipelines that gather the opportunities that may or may not fit into their credit box. So we’re seeing a lot of that just in a broad sense, but also specifically within the SBA marketplace. Are you seeing more banks being interested? You mentioned local banks and I work with a lot of banks and I’m surprised at the number that still feel like we don’t have any appetite for moving outside of a pretty well-defined geography and yet plenty of others who are very open to that.

I’m just curious what you see on the balance of that and how important do you think that is to be able to move outside of a narrow geographic band? I think it’s, and from the conversations with our bank clients, it’s incredibly important from a risk management standpoint, from a diversification of deal flow and portfolio construct, from a origination and servicing perspective. The capital markets offer a very efficient way to maintain that servicing cash flow, but be able to monetize those assets of which they’ve funded, originated and can sell off for gain or to generate liquidity to make more loans, but still maintain that servicing relationship. What would you say to those that are still reluctant because the old school thinking is if I’m going to gather deposits, that’s one thing.

When I’m going to make loans, I really need to know that I’m going to be able to get repaid and so I need to be able to look borrowers in the eye, see collateral when I drive down the street, that sort of thing. How do you think about that as you talk with banks about maybe raising the scope of what they’ve been doing? And again, it’s going to depend on the institution, but this, and again, coming back to the government guaranteed lending space, which is somewhat of a specialty space, but this can also be applied to call it indirect autos or other collateral types that you need to go more broad, equipment finance or some of these other things. But in the government space, you have this active and robust secondary market and we’ve seen smaller banks that begin to either partner with deal flow sources or have a growing national footprint that enables them to make these loans and sell off the, call it 75 to 85% of the loan into a secondary market, but still maintain that client relationship, but reduce their risk by a large percentage of the principle that they’ve put out.

So, yeah, you actually end up with some risk management enhancements by being able to do that and by being able to both diversify your portfolio and free up capital. That’s right. And the most active sellers that we see in our markets are the smaller institutions that need to have that velocity of capital to turn over their loan origination pipeline, get a nice gain on sale and be able to fund and make more loans.

So it becomes kind of all this machine of originate, sale, service. So because of the constraints on their balance sheet, so. That’s right.

That’s right. Let’s dive into SBA a little bit, maybe for those that may not be super familiar, just a high-level overview of what are some of the SBA programs, and we don’t need to go through each of them in great detail, but what do they look like? And you mentioned a key feature already, and that is the government guarantee. That’s right.

Yeah. So what’s that look like? So there are several key programs under the SBA’s umbrella, and they go from very large, which is the 7A program, the largest, down to some of the smaller community-focused type programs. And they have all different things in between, from 504 program, they have SBIC program.

All of these are different channels of which different types of borrowers or strategic investors can deploy capital, but have the benefit of the Small Business Administration guaranteeing a portion of the loan, essentially to incentivize these lenders to make the loans by being able to shed some of the risk with that SBA guarantee. And so what’s your role in the process? So Breen Capital is a licensed pool assembler. So we have the authority granted by the SBA to form SBA 7A floating rate pools with the guaranteed portions in compliance with the pooling rules and regulations that they have established to put these securities together.

So we are, as the largest pool assembler, we are a liquidity provider to the market. So we work with hundreds of banks across the country and non-bank lenders to provide them liquidity on the guaranteed portions of their loans, and sometimes the unguaranteed portions, form the pools, and then distribute those pools into the capital markets to help meet our investor needs. So we’re kind of like this entity that sits in the middle, that gathers all the guaranteed portions up, makes pools, sells individual loans, and manages the risk for each of the different stakeholders on both sides of us, whether it’s the investors or whether it’s our lender partners.

You’re sort of the bank to the bank, right? Because you’re distributing liquidity where it’s access to where it’s needed. Yeah, a little bit like that, yes. But from a benefit to the lenders that we partner with, for the year 2023, just based on the volume of loans that we purchased from our lender partners and provided liquidity for us, well north of $3 billion in loans, we were able to provide to our lender partners somewhere between $350 and $375 million of non-interest income, basically fee revenue.

To them for making those loans and selling them into the secondary market. So it’s a really meaningful revenue stream for the banks that participate in that program. So that ends up being a little bit of a double benefit, right? It not only provides them the income from that, it also shifts some of the income from interest income or net interest income, squeezed by the margins we were talking about, into fee income.

And that’s really important for banks to be able to find sources of fee income. Do you think this is a bit of a long-term shift in the banking business, right? Primarily, it has been a balance sheet business. And for some, it’s becoming a lot more of an income statement business where we don’t necessarily have to hold all the assets here.

But if we can be a conduit to making the relationship and generating the asset, we may be able to make income from fee income. And maybe we like that better. It’s more capital efficient.

Yeah, there’s two pieces to it. So the fee income, obviously, is the one that stands out at the front end of the transaction. They’ll get origination fees.

When they access the secondary market, they get the premium on the sale, which are hefty because they are full faith-in-credit, government-guaranteed assets that float. The vast majority of them, call it 98% of what we buy, will float every 90 days with no periodic or life cap. So from an investor perspective, it’s a very interesting and intriguing asset.

Those originating banks will also retain 1% servicing on the guaranteed portion that they sell. So if they make a $1 million loan and it’s got a 75% guarantee, they’re selling $750,000 into the secondary market. In that first year, they’ll receive $7,500 of servicing fee that when you calculate the rate of return on the unguaranteed portion that they retain between your gain on sale, between that 1% servicing plus the full coupon, or let’s say it’s prime plus two and three quarters or 11 and a quarter, where we are today with an eight and a half prime on 25% alone, add that $7,500 on top of it, it increases the overall rate of return on that SBA loan book of the portion they retain in the high teens at current levels, with the first year with the premium being well into the 20%.

So it’s a very, very interesting and profitable business for banks. Well, I wasn’t told there was going to be a math portion. So I’m glad you handled that part.

But it is interesting as you think about the space banks have been playing in, and we have seen quite a few banks that have kind of seeded the consumer business to the large banks, feel like they can’t keep up with the offerings, with the digitization, the arms race, and so on. And they really want to double down on small business. Yet not every bank is an SBA lender today.

Do you think more should be? I mean, from your perspective, the answer is probably yes. But as you just think about the industry, is that another arrow that should be in the quiver of more community banks? Well, naturally, it’s in my nature to say, yes, more is better. Fair enough.

Yeah. But I would couch that as there is more to it than just making 7A loans and selling them into the secondary market. And we see, I’ve been doing this for almost 30 years, but I’ve seen lenders be attracted by the shiny object, the fee income, the overall kind of program as I described.

But it’s important because it is a small community. There’s a handful of us that are the most active liquidity providers and pool assemblers in the market. But it’s important to be a good partner to the secondary market, make good loans, work with us when you sell a loan in the secondary market, and it pays off in 30 days or 60 days.

And having that access to the secondary market is critical to having a successful SBA 7A business. And we’ve seen, I think, if you look at the SBA’s website, the list of licensed pool assemblers is at an all-time high. We’re, I think, 19.

And we’ve seen some large banks come in. Wells Fargo is on there. JP Morgan is on there.

They’ve just reactivated their license to be a lender pooler, which means they want to pool their own loans. So we’re seeing, and I think I mentioned this when we spoke recently before this podcast, but it is the most transformative period, I believe, in the last 30 years that I’ve seen within the SBA. New entries, how lenders are sourcing deals in the partnerships with fintechs, the mission that’s being pushed and grown within the agency to reach more underserved borrowers.

We’re seeing the overall size of the loans come down from, say, an average of 500,000 over the last 10 years or so to closer to 200,000. That’s across all loans, which means that those smaller borrowers are being offered credit and capital that is needed to help them grow their business from the very, very small, local, you know, operating in the underserved communities to even much larger, because they’ve increased the size of the loan over the last 13 years to 5 million in size. So it’s broadening its access.

And that goes for both ways, up and down. But that goes to the size of the institutions that are looking to participate in this program from the local small banks that want to make the loan. They want to support the businesses in their communities, but they may not feel completely comfortable with the overall credit.

It may be a startup. It may be a business acquisition with a newer operator or something that doesn’t fit it perfectly in the box. And the SBA guarantee and the access to the secondary market are clearly there to help banks de-risk a little bit.

And with the large banks, it’s another tool, you know, within their lending apparatus of different programs to meet the different needs of the borrowers. This show is brought to you by Alloy Labs. As much as we love talking on the show, we believe that action is more valuable than talk.

Alloy Labs is the industry leader in helping fearless bankers drive exponential growth through collaboration, exclusive partnerships, and powerful network effects that give them an unfair advantage. Learn more at AlloyLabs.com. Alloy Labs, banking unbound. Well, let’s talk about the non-banks.

You mentioned FinTechs, as you call them, FinTech Lite. How’s that changing the landscape? What’s new? What’s different? And where do you see that going from here? Well, following the Triple P program, where the SBA was the vehicle and… Yeah, Paycheck Protection Program during the peak of the pandemic. Yep, that’s exactly right.

They had a front row seat and essentially had partnered with non-traditional lenders to help with the deployment of this large amount of funding to get into the needed businesses to support them during this time. Right. That I think they were impressed with the efficiencies of how they were able to adapt to the unique requirements of the SBA and the government program, but also be able to very efficiently deploy that capital into the marketplace.

So roll forward, call it 24 months. We’re kind of on the backside of the pandemic. Markets begin to normalize again.

And the SBA, for the first time in 40 years, approves lifting the moratorium of the issuance of additional SBLC licenses. These licenses give the authority to non-bank lenders the right or the capability to make SBA 7A loans and not be a regulated financial institution. They are regulated by the SBA.

And this, I think, is a direct result of how efficiently they move that capital through. So in conjunction with that, we have seen these fintechs that really embraced the deployment of the Triple P Paycheck Protection Program capital dollars using that technology that they built for this program, making some modifications and partnering with banks where they source all the deal flow, they underwrite the loans, and they partner with banks who have the authority to make them, underwrite them, finance them, and then they partner in the sale of the guaranteed portion. And they all have different arrangements around how they divide up the gain on sale.

And we’re seeing more of that. And it seems to be an efficient way that larger banks are sourcing deal flow and utilizing their balance sheet without having large origination departments. Yeah, you know, Triple P put such pressure on the entire industry, suddenly a massive amount of money that needed to get out, get in a lot of hands, get underwritten.

And sure enough, there were some challenges with that and some corners cut. And, you know, that’s maybe another show for another day. But to your point, that it was very clear that for most banks, the underlying technology just was not sufficient.

So it was necessary to partner with somebody. And, you know, as I wrote recently, more broadly, just FinTech in general, the genie is not going back in the bottle. And it’s not going to go back in the bottle around small business administration loans either, right? The technology is going to have a place to play.

The non-bank partners and lenders have a role in this. And so, you know, not only are the banks that are not participating in this space, probably in most cases need to do so, those that already are doing so also need to step up their game because the ability to, you know, move much faster and much more friction free through the use of good technology is really setting the bar. You know, nobody’s no customer wants to sit in an office, filling out a bunch of papers and pen and paper and expecting, you know, to hear back in a matter of weeks when they can type a few keys and hear back in a matter of minutes.

Right. Yeah. The tell the story, probably one of the most unique modernization things that came out the pandemic period was the settlement of the guaranteed portions into the secondary market historically required a wet signature.

And during… That was literally in the regs? It was in the regs. At the early couple of months of the pandemic, we couldn’t settle any loans because it required this wet signature and they modernized it very quickly. The ability for us to use DocuSign and accept the sharing of documents and things electronically to continue to provide that liquidity for those loans.

So it took us about two months and then we were able to pull the loans into securities again, but there was a period of two months where the market just kind of shut down. But yeah, the importance of innovation, both from the origination of these loans, utilizing technology to even the role that we play, you know, prior to joining Green Capital, I was at SunTrust Bank for almost 16 years, now Truist, and how we operated the business. We were the largest bank pool assembler during that time.

But I left the bank in late 2020 and was introduced to Breen. And really what excited me most was, one, they were not a licensed pool assembler already. So I had a clean slate of which to develop technology and stand up the business within the Breen platform, which is very technology forward, and develop a software solution that enabled me, with a very nimble and experienced team, the ability to both manage the data, manage the volume, and manage documentation in high volumes, which allowed us to really focus on the things that were most important.

And that’s best execution, best pricing, quickest settlement, and efficiency and velocity of our own capital of buying these loans and pooling them and moving them through into the capital markets. That’s an interesting perspective because you think about, we can talk about removing friction and increasing speed on the front end, on the application side, on the borrower side. It’s important on the back end, too, for all the reasons that you just cited.

And you look at somebody like Alive Oak Bank, who last time I checked, you tell me, but the last time I saw, they were the number one 7A lender. And they’re not even a top 50 bank, right? They’re not a giant bank, but they’re very focused. And I know they’ve worked really hard at building their own technology.

In fact, many people may know or may not even realize that Encino, a loan origination platform, came out of that because they built their own and ended up spinning it off as its own company. So that becomes really critical. The other thing that, from what I know of Alive Oak, they also seem to have some pretty good specializations around specific vertical, industry verticals.

So what are you seeing there from your perspective? Do you care? Is it, you know, do you look at some verticals more than others? Or is that all the same to you because of the government guarantee? But I’m just curious if you’re seeing anything in terms of trends and specialization. We say small business, but that means a million different things. Now, those are all really, really good observations, both from the Alive Oak perspective, the specialization or the unique, or I’m trying not to be redundant, but specialty verticals that they’ve participated in over the years.

But I know those guys well, and they’re a great bank and a wonderful partner to the secondary market. And all the things that I had touched on early on in this podcast of really partnering with the secondary market, and they utilize it. And they always have.

From the very beginning, it’s been critical to their success as a growing bank. But they’ve broadened out to make loans to much broader industry types. But they have also been very, very good at identifying industry types that have a better or slower prepayment profile.

Very early on in their existence as a growing 7A lender, they were a seller for servicing. So that would mean they would forego the premium of the secondary market, and they would take, instead of 1% servicing, they may take 300 basis points or 350. So they wanted that servicing cash flow to stay out there much longer and really dug in and did the work, mining data and understanding which industry types are slower payers.

They now sell for premium like everybody else. But to your point, from a secondary market perspective, our job as the liquidity provider and pool assembler, we bring in all of the industry types. And then as we construct the securities, we want to make sure we construct them in a way that is investor desirable.

So you want to have diversification of geography, diversification of industry type. Some of the pooling rules allow different origination years to be put together, but we want to kind of get them to be as uniform as they can. And then lastly, if there are large premiums on the pools that we’re issuing, having enough diversification of loan size so that we don’t have that premium concentrated in a small amount of loans within the pool.

So having a good loan count there. So all of the things that Live Oak looked at in the early days on how they were constructing their business, all of that gets translated and is utilized similar in how we put the pools together. Whole industry is maturing and getting more efficient.

What would you say to the banks that aren’t there yet? Maybe they aren’t participating in the space or they are at a very low level. What were the top one or two or three things they ought to think about as a first step to start dipping their toes in the water? Well, I’d say, come on in. The water’s great.

The things that I think they have to ask themselves internally, whether it’s at the board level or at the ALCO level, what does the balance sheet of the bank look like? Do we have a certain concentration of a particular type of loan that we’re making that gives us more interest rate risk or exposure to particular industry type that may be more than we had anticipated? Whether it’s successful and they’re making good margin on all of that aside, there are risks that come with concentration. Does the SBA program, because it is unique and a specialty program, you got to understand how to navigate underwriting the loans correctly and that. Does the opportunity with the economics that drive an SBA origination platform make sense for the bank to deploy or invest the capital to make this business be successful? And what does that take? And then probably the third thing is if we entered into this business, get the team, get the specialty expertise, is this something that we can be successful at in getting the right kind of deal flow? And is our local market big enough? If it’s not, how do we go and access other markets? What are the right markets to go into? Who are the right partners in those markets? So I think those would be the three main things.

And I suspect along with that, too, is who do you want to partner with, right? Are you going to do all of this in-house? Are you going to partner with somebody, whether it’s on the front end, the back end, somebody like you, for instance, as a liquidity provider? But on the front end with a FinTech, do we want a different underwriting platform, a different application program, a different way of gathering the financials and materials that we need? I know this is something a lot of banks are working on. A lot of what I have been working on is improving those bank FinTech partnerships. In fact, I’ll be talking about that to a lot of your banks at your conference coming up in September.

Joel, we haven’t asked you much yet. I’d love for you to weigh in on anything that Steve said, but maybe talk a little bit about the conference you’re putting together and who should be there. Yeah, certainly.

And again, thank you so much for having me and us on. And to that end, Steve’s been, he and I have worked together 15 plus, probably 17, 18 plus years. Steve’s been super focused in that SBA space and leading the charge, as you’ve probably identified just through his commentary.

I would say somewhat more broadly, I’ve been focused on the holistic balance sheet as an AL techie guy for most of those years and working on development of depository fixed income services in that capacity, helping community depositories manage their balance sheets at large, mostly at the NIM for full disclosure. So to that end, and to your point, JP, we have that conference coming up in Nashville, Depository Conference, Estressed Depositories. This one is focused on the community institutions, both banks and CUs alike in that community bank range.

So you’re $200 million, and we’re going to have tails. We’ll have institutions smaller. That’s just fine.

To the $10 and $15 and $20 billion and probably a few outliers there as well with folks’ kind of specialty focus in attendance. That’s going to be in Nashville on Wednesday, September 11th through Friday, September 13th. Not to get into too many details, obviously, but Wednesday the 11th through Friday the 13th of September, which happens to be Music City Grand Prix weekend.

So it’s going to make for the regular crowd plus a whole lot more and a whole lot of additional interest and a whole lot of fun for the venue that we’ve selected and the time frame in which we’ve selected it. But if you’ve enjoyed kind of some of the conversation and some of the detail and color that Steve’s brought on SBA, they’re going to be cleanup session on day one of the full day one, if you would, of our session. It’ll be the last session of the day coming from the SBA desk and the ways that Steve and company provide color on that.

And then, JP, you’re our keynote speaker to lead us off on the Friday morning of day two, and we get to get outside of the NIM and we get to get into much of the additional value of growth and relationship building from outside what this particular audience of folks that will have in attendance deal with probably too much of the time as they migrate some focus from the direct NIM related to the to the non NIM related areas of key importance for growing relationships, growing their institutions. So that’s what we have going on. We’ve got a great venue just across the street from on Broadway near Bridgestone Arena.

So we’re right in the heart of it all. I would say the easiest way to go about if you have interest in learning more, if any of the folks listening to the podcast have interest in learning more, of course, we’re looking for the depository attendees, if you would. It’s FIConference2024atBreamCapital.com, FIConference2024atBreamCapital.com. If you shoot us an email, we’ll be happy to direct you to the right web page information, to peruse at your leisure all about the details of that couple day conference over in Nashville at Music City Grand Prix weekend.

Well, I’ll put that in the show notes as well. And I’m looking forward to joining you. I know many of my colleagues will be in New York for Finovate earlier in the week.

So while you’re on the eastern third of the country, come on over to Nashville, join us for the end of the week. As you said, I am going to talk about some of the secrets of NIM. I’m bringing with me a couple of interesting case studies that look at how banks are really adding non-rate value through partnerships and through new products and value propositions that are helping to reduce that NIM compression.

So I think there’s a lot of hidden levers for people to pull. That was really the whole point of our conversation today. I’ve got a whole blog post coming out on that.

And I’m looking forward to being live on the stage with you in Nashville, coming up here in just a few weeks, but 60 days from now. So all right. Well, gentlemen, thank you for joining us today.

Thank you for sharing your expertise and perspective on this very important topic. And we’ll be back with more Breaking Banks next week. That’s it for another week of the world’s number one fintech podcast and radio show, Breaking Banks.

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