Back to the Future: The Road Forward


road-ahead.jpgWith traditional bank lending, one of the credit risk red flags was always a lack of borrower diversity. How could a company risk having all its eggs in one basket? The extra pain extracted from highly correlated bank portfolios (i.e. both with real estate and geographic concentrations) in this crisis has brought that proverbial chicken home to roost in our own industry. Conceptually, we all now understand this; how do we practically affect this change?

Here’s a possible five-step plan for your bank to consider:

Step One: Adopt strategic plans that include alternative loan products, such as those tied to C&I (commercial & industrial) lending, or indirect / dealer automobile lending or even mortgage warehousing. Small Business Administration loans are another possibility. Recruit the talent that can implement these strategies for you.

Step Two: Disabuse yourselves of the following anti-C&I biases:

  • It’s become just a consumerized product. This is a byproduct of the underwriting laziness adopted by many, where a small business owner’s credit score was the primary driver for this loan product.
  • It’s tantamount to unsecured lending. Because it tends to focus on the top of the balance sheet, assets for collateral, lines of credit can be monitored effectively by procedures that use collateral such as stepped borrowing base agreements.
  • It’s asset-based lending. We’re not talking about factoring-like products (buying or funding a customer’s accounts receivable at a discount) that proliferated the ’90’s. They often failed because they were unwisely sold to banks as having primarily operational rather than credit risks at their heart.

Step Three: Ditch (or at least modify) the hunter-skinner delivery system for your bank’s loan officers. It doesn’t work. Some of the so-called efficiencies gained lend themselves better to the book and forget mindset that too often characterized our industry’s fixation on commercial real estate. This strategy also robs us of broad-based credit talent needed to fulfill the axiom: the market place rewards value-added.

Step Four: Train and re-train lenders and related lending staff (analysts, underwriters, credit officers) in the ways of cash flow and cash cycle analyses. Twenty years ago, most commercial bankers were experts in these classical credit tenets—and frankly treated real estate as a form of specialty lending. Over the past decade, commercial banks have been copying mortgage lending, abdicating too much of their core underwriting to third parties such as appraisers and credit rating agencies. The fundamentals of classic credit underwriting are not that intimidating—and like riding a bike, can come back to even the most dedicated commercial real estate devotees.

Step Five: Create the infrastructure needed to deliver and oversee this diversity investment. In addition to front-end underwriting, enhance:

  • Use of practical loan covenants and borrowing base certificates to justify lines of credit;
  • Portfolio servicing (post-booking checks of a borrower’s risk trends);
  • Probative risk management tools (looking at future risks);
  • Staff. Remember, the cost of one or two additional full-time equivalents pales in comparison to the bloodletting the industry has experienced, due in some part to bare-boned risk management infrastructures.

Lest one think these initiatives are designed to address only the risk component of lending, I would offer that they also help return the community banker back to the successful production role of lending to a diverse borrowing base: a win-win.

*Another version of this article was previously published in Carolina Banker in 2009.

What Have We Wrought? How Can We Atone?


training.jpgI know, I know, this may not be the time or the venue for industry self-flagellation, but like the twelve-step programs and most religious admonitions, one cannot change or eliminate bad habits or poor behavior without first acknowledging the problem. That one key problem for community banking—both relative to this crisis and the continuation of our business model—is the dearth of classically trained credit talent remaining in our industry.

We know the primary culprit: the big bank fixation on the efficiencies of the hunter-skinner template for credit delivery. Are we not now paying exponentially for those “savings” now? I’ve said for years that I knew of no other industry that has been successful putting people on the street selling a product or service with such limited knowledge or training.  Most devastatingly, adherence to that model has ended the en masse credit training that had been the font of credit talent that ultimately found its way to the community banks. Even without this economic tsunami, our niche of the industry was facing a crisis over how to staff lending functions with people who actually knew credit. These are the people who provide value to both risk management and the borrowing customer—knowledge that is arguably at the heart of community banking’s popularity and viability. Simply put, due to big bank strategies and retirement factors, there’s less credit talent per capita in banking today than ever before.

What can be done? Like the so-called aging infrastructure of America, rebuilding our depleting credit talent pool needs significant investment and high profile support—support at the highest levels of our banks, including boards and CEOs.  Credit training can no longer be seen as just a discretionary non-interest expense item available for the budget balancing axe. Even at Credit Risk Management, L.L.C. (CRM), training revenue has been down about 25 percent since the onset of the crisis in ’08—understandable for the times, but a trend that must be reversed. Credit training, of course, can take many forms: in-bank, trade association-sponsored, and vendor-directed. Each bank needs to devise a strategy that works best for its talent needs.

One initiative that banks should consider is re-invigorating the formal or informal peer group training programs, where costs can be shared and curriculum can be customized. Also, look for schools with graduated levels of complexity in the two primary branches of commercial lending: C&I (commercial & industrial) and CRE (commercial real estate). Community banking in particular needs diversity away from real estate. Focus on schools where the curriculum will be focused totally on credit underwriting and analysis, using case studies, mock presentations, and computer tools—not ancillary issues like loan review or effective officer call programs. And to ensure the cost justification for the bank’s investment in sending students, ensure that the program include at certain stages some testing and certification. 

Even with all the turmoil and economic pain our industry is currently experiencing, I subscribe to the Chinese adage that within every problem lays an opportunity. Our opportunity is to begin now to build the next version of the business model for community banking, and credit training must be a vital part of that re-building strategy. Accordingly, I implore you community banking leaders—executive management and board directors—to first acknowledge this depleted credit talent problem, and then to see some way to budget for training opportunities as not only investments in enhanced risk management, which we obviously need, but as investments, too, in the marketing and survival of our niche in the broader industry.