Lending to Natural Foods Cooperatives

Last year, NCB conducted a focus group with representatives of the natural foods industry to help us understand better the perception that you, our customers and partners in the natural foods industry, have of us and the kinds of products and services you need. In a recent issue of Cooperative Grocer (#78, Sep.-Oct. 1998), we reported to you a summary of those findings, discussed how NCB has been challenged by you to grow and improve, and outlined some of the steps we are taking to rise to these challenges.

In this article, we are following up to discuss some of the issues we face as bankers and specifically constraints and opportunities within which NCB operates that affect how we interact with you. How can NCB best serve the industry and remain financially viable? What determines how we price our products and services? How do the changes in the natural foods industry affect our relationship with you?

Co-op managers and directors understand well the need to balance competing demands in providing the best service to members while remaining profitable. In-deed, what cooperative hasn't had to juggle the requests and needs of its members with the economic realities of its business? This tension calls us to be our best and most creative. Just as you struggle to move forward in your industry, addressing such issues as more demanding and sophisticated consumers or large and aggressive competitors, so NCB is grappling with tough issues in its industry. These include intense competition among banking institutions, high capital and labor costs, and the need to control overall operating expenses.

How is NCB addressing the challenges it faces in the market? An important exercise is to rigorously evaluate what services we should offer and how most efficiently to deliver those services. Continuing this dialog with you, our customers and our partners, will allow us to work together to improve the ways in which we serve you.

Central challenge: meet industry needs, remain profitable

One of the biggest challenges we face as lenders can be illustrated by quotes from two participants in the focus group:

"I think it would be so much better if the Bank could step in with a better understanding of how a co-op at $300,000 or $500,00 [in annual sales] is going to grow. If the loan officer could take them by the hand and help them move that way, that would be so much better."

"You don't want to make a lot of little loans out there. It costs you a fortune."

The first quote speaks to the need of a number of cooperatives for a broad range of technical assistance, both financial and operational. Many of you are clearly looking for a partner who can offer more than just access to capital. The second quote illustrates the challenge NCB faces in offering small loans on a national basis while remaining profitable.

We discussed in our previous article (and mention below) some of the initiatives NCB has helped finance that provide technical assistance in all areas of your business. Regarding direct lending, one area that we have recently addressed is our ability to offer competitively priced and structured small loans. Using traditional underwriting techniques involving extensive discussions with the borrower and site visits does cost a significant amount. And when a loan is small, it is difficult for the income from the loan to cover those expenses. One way NCB has begun to address this is through new technology and commitment to a high volume, low overhead small loan unit, NCB's Priority Banking Center, a group dedicated to offering small loans to borrowers in all the industries we serve. The center uses a combination of efficient processing, standardized product, and advanced technology to minimize the costs associated with underwriting and closing standard small business loans.

The Community Ventures Team is currently collaborating with the Priority Banking Center to create a product tailored specifically to natural food cooperatives. You will be hearing more about this very soon. While this product will not always be the right answer for all of our customers, it will offer another option in certain circumstances.

Of course, NCB expects to remain competitive when it comes to providing larger, more complicated loans that require significant structuring and discussions with the borrower. While these loans tend to be time and labor intensive, these costs are amortized over a larger loan amount, thereby improving our economics.

Another issue our borrowers discuss is loan pricing. Clearly, everyone wants their loan at the lowest possible cost. NCB faces a unique environment in obtaining its funds to lend to our borrowers. As most of you know, NCB is not a deposit taking institution. Without access to these deposits, NCB must obtain its funds through the capital markets. Basically, NCB borrows a large part of the funds it has to lend. Given our size and our inability to access low-cost deposits, at times our cost of funds can be more expensive than some of our competitors. However, NCB is constantly negotiating with its lenders for the best rates so that it can offer the most attractive prices to our borrowers. And just as is the case for your cooperative, NCB returns its income to its borrowers/owners in the form of patronage dividends, which substantially reduces the cost of doing business with us. We should add that the interest rate on a loan is only one of many considerations when choosing a lender. Loan terms and structure are frequently much more important in affecting the success or failure of a project.

NCB remains committed to supporting the cooperative model in all industries and specifically in natural foods. Supporting cooperatives is our reason for existence, a focus that is true of no other financial institution. It is a commitment you can count on. Far too often, bankers will run after a market in good times and run from an industry in bad times, abandoning customers just when they need help the most. NCB knows its customers and we make every effort to consistently serve them year after year, in good times and in bad.

NCB supports the needs of your industry through other avenues as well. We have helped create and fund a number of industry initiatives, including CGIN and various capacity building programs sponsored by Northcountry Cooperative Development Fund, Cooperative Development Services, and the UW Center for Cooperatives.

NCB market: across the U.S.

Another important consideration in determining how we serve you is that NCB offers its services throughout the United States. Given our small size as compared to most national lenders, our challenge is determining how we serve such a large market efficiently. Just as it can be prohibitively expensive to bake bread in California to sell in New York, so at times local lenders have an inherent cost advantage over national rivals. However, as a national institution focused on cooperatives, we work in your industry constantly. Your local banker may have only one natural foods cooperative (namely you) as a customer. The local bank may not bring the perspective or experience necessary to work with you to structure the best transaction. Even other national lenders are likely to have local or regional lending officers who do not have a national perspective. NCB has a team of lenders that is dedicated to the natural food industry and brings that perspective when working with you.

What are some other implications of size and national scope? The first is in how we can market our services. It probably takes a little more energy and expense for NCB to visit your store than it does for the banker down the street from you. Similarly, underwriting loans can be slightly more expensive when the lender is not physically proximate to the borrowers. Finally, because NCB is not local, we at times will see proposals that have already been shopped to the local banks, who for whatever reason are unwilling to provide assistance. While we don't shrink from the challenge of doing a harder deal or one that other institutions have declined, a more difficult deal will need to be priced and structured to reflect that risk.

Another challenge for us is offering construction loans, a product much demanded in the industry and which typically requires a local presence to monitor. To assist us in efficiently monitoring construction loans, NCB has established a construction lending group. This group typically will work with a local construction monitoring firm, the architect and general contractor, and your loan officer to ensure that you are receiving the contracted services properly.

Natural foods industry knowledge

The fact that NCB has a history of lending nationally means that we have a depth of experience that few other institutions can match, for good and bad; we have seen what has worked and what hasn't. We have seen co-ops structure successful expansions and we have seen them move ahead prematurely or too aggressively. On occasion you will tell us that either our covenant package or pricing is not as attractive as another lender's. While we always want to understand what our competition is offering, sometimes we may have a different perspective on the project.

Often a borrower will want our advice on structuring, but at the same time does not want to hear, for example, that we believe more member equity is necessary. Delivering difficult news to our borrowers is never easy, especially if other sources of financing appear more attractive to the borrower. But we think this is when NCB's unique position as a partner to the industry most comes into play. No customer wants to have us put constraints on their projects, but our motivation is not solely to increase our returns and minimize risk, but to ensure that you have a sound project that can be managed by your organization. We would rather lose a deal on a project that we believe is financially unwise than match a bid from a competitor. We think it is our job to provide you our frank assessment of projects when you ask us and to discuss our rationale for the structure we present to you. While we may not always agree, perhaps there will be some benefit gained in sharing perspectives.

To reiterate, we are committed to being in this market, and we frequently put in the time and resources necessary to structure a transaction that gets financed. We see many banks that invest much less time and energy in working with a potential borrower to create a "financeable" project. Before closing this discussion about the environment facing NCB and NCB Development Corporation, we want to emphasize again one element of who we are that we feel aligns us more closely to you than any other financial institution. That is of course that we are a cooperative ourselves. While we must make sound business decisions, just as you do in your business, our borrowers are also our owners. We are not out to charge as much as we can get away with, or structure a loan that is in our interest but not yours. It takes a co-op to know a co-op. In the midst of negotiating a deal, both parties can lose sight of this. But remembering this simple fact can reaffirm that we are in a partnership and must seek the solution that works for both of us.

Challenges facing our customers

On a daily basis in all its markets, NCB is faced with the issues we've discussed above. What, you might ask, specific to natural foods cooperatives, affects our work in this industry? In a word, survival. While it is not too much of a stretch to say that you created this industry, you are also working hard to remain players in it. While many of you are meeting these challenges head on, the level of competition has never been greater. While the market is expanding, well capitalized firms are entering aggressively. We can expect consolidation and that many weak players will exit.

This is not to say that there will not continue to be many successful cooperatives. It is our belief that, to be successful, each natural foods retailer will have to know exactly what its competitive advantage is. What combination of products, services, convenience and price do you offer that no one else does? Given an industry that is changing rapidly, many strategies will have to be thought anew.

NCB is committed to working with you as you address your business issues. We hope this has helped you understand some of the challenges we face and has conveyed the seriousness of our commitment to meet and exceed your expectations of us. We continue to welcome your feedback and perspective on NCB and the natural foods industry.

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