Magazine Exclusive: Finding Your Lane

*The following feature appears in the second quarter 2025 issue of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Program. Learn more about subscribing here.

Robert Talerman considers himself among the lucky who get to live in Cape Cod year around.
The region, which makes up the hook-shaped peninsula in Massachusetts, is beautiful for its miles of coastline, beaches and waterways.

“The natural beauty is the economy of the Cape and the islands,” says Talerman, president at Cape Cod Five Cents Savings Bank in Hyannis, Massachusetts. “It’s all that coastline and beaches and ponds and waterways. It’s why people come here to vacation or retire here.”

But the majority of the buildings in Cape Cod use septic tanks, rather than hooking up to a sewer system. That means the area’s water is vulnerable to nutrient pollutants that can seep into the sandy soil. To solve this issue, towns are now requiring building owners to connect to a sewer system. It’s a massive, but necessary, undertaking that will span decades and potentially cost property owners tens of thousands of dollars.

To alleviate the financial strain, $5.7 billion Cape Cod 5, a subsidiary of Mutual Bancorp, created a business line offering financing to commercial and residential property owners who need to pay for the sewer connection upgrades. “Our job is to serve our market, to understand where our market might be unique compared with another market and help our clients, both consumers and businesses, be successful,” Talerman says. “It’s a nice way to align with our clients’ needs, reach prospective new clients, and it’s good for the region.”

It’s also an example of niche lending, an area that community banks enter to boost loan demand and avoid concentrations. But competing in a niche lending line also requires internal expertise of the segments and industries that the bank is looking to target. That can mean more specialized underwriting and knowledge.

“A niche lender has the credit risk management in place that is tailored to that niche,” says Claude Hanley, a partner who leads the financial management and regulatory practice at the consulting firm Capital Performance Group. “A niche lender knows exactly how to assess the collateral involved in the loan. They have a sense of who will default. They have a pretty good idea how to repossess the collateral if necessary. They know the players involved so they can qualify a borrower fairly quickly.”

Understanding the Business Line
Historically, community bank lending has been concentrated in commercial real estate. At the median, these loans made up almost 36% of portfolios at banks with market capitalizations of less than $1 billion in the third quarter of 2024, according to an analysis of publicly traded banks by the capital markets firm Janney Montgomery Scott. This median is about 28% for institutions with market capitalizations of at least $1 billion. At the same time, the Federal Reserve warned in November 2024 that CRE delinquency rates had reached their highest level since 2014.

Additionally, banks face significant competition. Last year, there were about 4,500 banks in addition to roughly the same number of credit unions, according to federal regulators. And that’s not to mention nonbank lenders, which have captured almost two-thirds of non-real estate commercial, 79% of residential mortgage and 59% of consumer credit lending, according to data from Keefe, Bruyette & Woods. Overall, KBW expected loan growth to be around 5% this year.

All of this has some bankers considering how to carve out a business model that ensures the long-term viability of their institution.

“Anyone can distinguish themselves in the market by saying, ‘I’m a low-cost producer’ or, ‘We provide the best customer service,’” says Robert Stark, president of the equipment finance division at $3.1 billion Stearns Bank, a subsidiary of Stearns Financial Services in St. Cloud, Minnesota. “But we live in a hypercompetitive industry, and there are a lot of banks or independent finance companies, so how do you set yourself apart? You can become a niche player,” he adds.

In general, niche lending requires a bank to gain enough knowledge and expertise to make credit decisions quickly for the targeted customers. This means knowing that specific sector’s regulatory environment, ebbs and flows, key players, significant risks, collateral and its resale value, and much more.

Frequently, this entails originating commercial and industrial loans, and is a way to bolster that portfolio. However, many lenders will also look to make CRE loans to companies within their targeted niches.

“I can understand why, particularly in this lending market, it is important to understand where else growth might come from, if not in traditional lending spaces,” Mike Budinger, credit solutions principal at Crowe, says of smaller banks pursuing niche verticals. “Niche lending is also a way to differentiate yourself from other community banks.”

When it comes to finding niches that banks can target, there are the more common ones that come to mind, such as working with law firms, accounting practices and restaurants. But beyond that, a bank looking at niche lending can really target any segment, or even subsegment, that it would like. “Niche lending is lending that has enough regressions from the normal that a banker with dedicated knowledge and products has an advantage,” says Steven Reider, president of the consulting firm Bancography. “That’s what banks should consider when thinking about getting into these verticals.”

Cape Cod 5’s loans to businesses needing to hook up to a centralized sewer system are a unique example of this strategy, given that it’s targeting a specific need within its community rather than a certain industry, which is more common. But the principles behind the product are still much the same. The bank has developed a product and an underwriting process that should allow it to make credit decisions quickly.

Commercial sewer connection loan terms will be up to 10 years and range from $10,000 to $100,000. The credits are being underwritten as a furniture, fixtures and equipment secured loans, and fall under the C&I category. This makes the process quicker for both the bank and borrower. Borrowers will be required to have a deposit account with Cape Cod 5 to receive the funding.

So far, Cape Cod 5 hasn’t originated any sewer loans yet, but several are in the works, Talerman says. The bank has structured the product to be profitable, but management also recognizes that this business line can’t be — and certainly isn’t — its only source of lending. “It’s an opportunity to serve the needs of our market,” Talerman adds. “We have structured the loans in such a way that it works for us, and it’s fair to our customers. The only way we can make a meaningful difference for our customers is by remaining financially viable.”

Banks can deepen their niche relationships by offering other types of services, such as Treasury management, wealth management or credit cards, that commercial customers may need. At the same time, these services can be a source of fee income for niche players.

Niche lending can also be more profitable for a bank. The average loan yields will be higher because there is likely less competition, so there will be “less chance of prices getting bid down to absolute minimums,” Reider says. Plus, this heightened level of expertise required for niche lending means the bank can charge more for its services.

“The young, broke 20-something is content with Domino’s Pizza, so long as it’s fast and cheap. A more mature consumer would opt to pay more for the high quality, local, independent pizzeria,” Reider adds. “And in the same way, borrowers choose on more than price. A borrower won’t forsake a bank with a deep understanding of their business or quick responsiveness or valuable add-on services … simply to save 25 basis points.” The more specialized the niche, the more important industry knowledge and specialized terms become to the borrower, he says.

Building a Client Base
Perhaps the most important mantra of any niche lender is this: Know the segment that you are trying to reach. Without this expertise, it is difficult to successfully serve those businesses. Essentially, companies want to know that they will be able to secure financing when needed. Banks that can do this well become “almost like a partner” to the commercial clients they are targeting, Reider says.

Banks build this internal expertise in a few ways, the first being potentially hiring a team of lenders with the desired experience from another institution. With this strategy, the bank can usually make the niche lending line profitable within six to 12 months, says Joel Pruis, senior director in the commercial and small-business segments at the consulting firm Cornerstone Advisors. But these hiring opportunities are rare.

Or an institution may develop the knowledge organically over years of working with a specific industry. It’s not uncommon for a community bank to complete a one-off deal to a business in a certain industry and then for that borrower to recommend the bank to their own colleagues. From there, a niche lending line is born. Through this strategy, it can take 18 to 24 months for the bank to break into the network and then another 12 to 18 months to become an established niche lender. “After that, the machine should start humming,” Pruis adds.

Demonstrating expertise is essential if a bank wants to develop a strong referral base. Stearns Bank provides financing for equipment purchases within several verticals, including audiology, optometry and veterinary practices in addition to serving the construction, manufacturing and transportation industries. It competes in this business on a national scale because it often works with equipment manufacturers and dealers that serve clients across the country. The bank provides financing to customers looking to purchase equipment from the dealers and manufacturers. But to establish these connections, a bank has to be knowledgeable about the segment. “We are trying to create and foster relationships to get trust with those dealers,” Stark adds.

Over the last 13 years, $47 billion Cadence Bank in Tupelo, Mississippi, has developed a network of restaurants that it serves through its franchise financing business. It focuses on national brands, such as Panera Bread, Wendy’s, Wingstop and Five Guys. In general, the operators it works with have more than 20 locations. It also has a group of lenders that help secure Small Business Administration loans for smaller franchisees. Frequently, the corporate office of a restaurant chain will have a list of lenders it recommends to the individuals operating the franchise locations, says Dan Holland, executive vice president and senior managing director of Georgia corporate banking and franchise finance at Cadence.

Besides that, the Cadence team will attend trade shows to meet potential borrowers, and referrals from existing customers help drive new business, says Holland, who has been in franchise lending for almost 30 years. “Your ability to execute and be creative with a client goes a long way,” he adds. “Being able to close loans is really the best way to attract new clients. That’s what our team focuses on.”

The More You Know
Being well-versed in the intricacies of an industry is important beyond just establishing a client base. It’s also a critical part of ensuring these loans are properly underwritten and reducing the likelihood the portfolio sours. To avoid potential issues, the bank should develop a deep knowledge of the target vertical’s regulation, economic cycles and competitive landscape, not to mention regular monitoring of the individual borrowers’ financial condition and collateral valuations.

Holland’s franchise finance team has to be aware of trends within the restaurant industry and how that might affect its borrowers’ ability to repay loans. The most obvious example of this would be the Covid-19 pandemic, which led to state and local governments closing nonessential businesses. These mandates affected much of the sector during those tumultuous months in 2020. Fears about Covid-19 also kept many customers home or drove them to take-out restaurants.

But Holland’s team also has to stay on top of other, more subtle shifts in consumer behavior. For instance, some dine-in chains that cater to low- and middle-income diners have struggled in recent years, such as TGI Fridays, which recently filed for Chapter 11 bankruptcy. Other fast food and fast-casual chains, such as Chipotle Mexican Grill, have thrived. “All brands will go through cycles,” Holland adds. “You will have ups and downs no matter what. It’s just the nature of the business. Consumer preferences change, so you have to be nimble when thinking about how you lend money to this industry.”

For the last decade, Forbright in Chevy Chase, Maryland, has been lending to a subset of the healthcare sector, mainly to facilities that provide skilled nursing, senior housing, behavioral health services, and addiction treatment and recovery. Many of the $7.2 billion bank’s lenders are veterans in this field. “There is real institutional familiarity with this,” says Jonathan Grenier, managing director of Forbright’s healthcare lending team. “We understand the risks. We understand the big operators.”

Forbright’s management sees the business line as largely recession-proof — in general, people need healthcare when they need it. Additionally, the U.S. population is aging, a trend that will continue for the next 25 years before leveling out. That is necessitating the building of more skilled nursing operations and other types of facilities to care for seniors.

Forbright generally works with operators that may own a dozen or more locations. Much of the underwriting is similar to other types of loans that banks originate. Forbright has the property appraised, if the deal involves real estate. Its lenders research the market supply and demand for the type of healthcare facility, determine the track record of the operator and review the background of the executives involved in the facility.

But this type of lending requires knowing the ins and outs of the healthcare sector, an incredibly complicated and highly regulated industry. The operators that Forbright works with are paid by private insurance companies and government programs such as Medicare and Medicaid. That means those facilities must be able to navigate any legislative changes that could affect these areas. In turn, Forbright also needs to understand how its borrowers would weather any policy shifts.

“Healthcare is so complicated that the operators with the best outcomes have the skill to understand the regulation,” Grenier says. “We also spend a lot of time and resources working with industry experts and lawyers, and really monitoring what’s going on.”

Mitigating Other Risks
Since many of these niche loans are C&I, a big challenge is the potential collateral involved if the loan sours. Because of that, a niche lender must have the ability to repossess, value and resell the collateral. This can be especially difficult if the niche lender does the business on a national scale. “If you are involved in a niche, then you need to think about how you will repossess the collateral, if need be,” says Hanley, the partner from Capital Performance Group. “Understanding the underlying dynamics of the business you are lending to at an incredibly high level is the expertise you need. How can you structure the deal, how much will you extend in terms of financing and how will you monitor the loan.”

The lenders at Stearns Bank, the Minnesota institution that provides equipment financing, have in-depth knowledge of what different equipment is worth. Potentially repossessing a bulldozer is a good example of this. Its remarketing team knows, based on several factors such as the vehicle’s model year and engine size, how much they can resell it for, Stark says. The bank decides whether to try and sell the equipment back to the manufacturer or to auction it off.

“Is the borrower willing to let us pick up the truck? You have to have relationships with a person who is even able to pick it up,” Stark adds, outlining more of the factors that need to be considered. “In the rare instance when we have to do that, we know we can move it. We don’t have pieces of inventory sitting around, which isn’t doing anyone any good. We are experts and know what to do,” Stark says.

Another significant issue that must be accounted for in niche lending is concentration limits. Many banks turn to C&I, and niche lending more specifically, to diversify their portfolios away from being heavily concentrated in CRE. And if the bank is doing the niche lending line on a national scale, then it can also provide geographic diversity.

But at the same time, the bank has to be careful to not get too heavily concentrated in one industry vertical. Every industry has its own economic cycle. Watching concentration limits ensures the bank won’t take a fatal hit if the underlying industry falters.

Fremont Bank, the $5.8 billion bank subsidiary of Fremont Bancorp., focuses on a number of niche areas, including lending to country clubs and nonprofits. But the Fremont, California, institution keeps a close eye on what percentage of the loan portfolio any of its niches make up. That’s important because donations to nonprofits and country club membership dues may be some of the first items consumers cut if their household budgets become constrained.

“We do have relatively tight limits that are set according to our capital,” says Don Marek, president at Fremont Bank. “We work with the board to consciously decide if we want to breach that, because we have had a certain level of success and profitability from that.”

Besides that, Fremont is sensitive to the potential reputational risks of lending to nonprofits. No institution wants to take over equipment or real estate that was once owned by a beloved local charity if that organization defaults on the loan. “The collateral has to be the absolute last thing you look at,” Marek says.

To prevent that scenario, the bank does a deep dive into the nonprofit’s mission and cash flow to ensure both are sustainable. The bank has to understand where the nonprofit’s funding is coming from, such as grants or donations. Monitoring these customers happens on a quarterly basis to ensure the organization is meeting the budget it outlined. The bank stays in close contact with these borrowers during times of distress, including earlier this year when the Trump administration implemented a federal funding freeze that included money earmarked for charities.

“Having navigated similar cycles in the past, our strong partnerships and deep understanding of our clients’ needs have allowed us to offer crucial assistance, in some cases helping them remain operational,” Marek says. “This truly underscores the value of a genuine banking relationship: When challenges arise, having a bank and banker in your corner can make all the difference.”

In terms of country club lending, there are emerging trends that the bank keeps an eye on. For instance, more country clubs are adding yoga studios and building kids club areas to better accommodate families. Even in California, where the weather typically allows for outdoor activities year-round, there is cyclicality to the business. More rounds of golf are played in the spring and summer, affecting a country club’s cash flow in the off season, Marek says.

Unlike some other niche lenders, Fremont has chosen to keep its niche lending within its geographic footprint. Marek believes this helps the bank know its customers better than if the institution was working with entities across the U.S. That in turn helps management manage the risks. “On a national scale, I think you run the risk of getting complacent on just accepting certain underwriting terms that just work, and you start to focus on the mean or the average rather than the specifics of that deal,” Marek adds. “But what happens when things really go sideways?”

Cape Cod 5 is also providing credit to its local communities, rather than looking to originate its niche loans on a national scale. Besides its sewer connection financing, it also provides credit for homeowners to build accessory dwelling units on their properties. These units are meant to create additional housing on the peninsula for long-term renters or family members.

The institution’s focus on its local market is partly due to its thrift roots, Talerman says. Management sees helping to solve local issues as part of its core mandate as a community savings bank. “We are looking for some of those niche opportunities to make sure we continue to serve our community’s needs,” Talerman adds. “That’s important to our long-term viability and the health of our market.”