Safeguarding Credit Portfolios in Today’s Uncertain Economic Landscape

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Rising interest rates are impacting borrowers across the nation. The Federal Open Market Committee decided to raise the federal funds rate by 75 basis points in its June, July and September meetings, the largest increases in three decades. Additional increases are expected to come later this year in an attempt to slow demand.

These market conditions present significant potential challenges for community institutions and their commercial borrowers. To weather themselves against the looming storm, community bankers should take proactive steps to safeguard their portfolios and support their borrowers before issues arise.

During uncertain market conditions, it’s even more critical for banks to keep a close pulse on borrower relationships. Begin monitoring loans that may be at risk; this includes loans in construction, upcoming renewals, loans without annual caps on rate increases and past due loans. Initiating more frequent check-ins to evaluate each borrower’s unique situation and anticipated trajectory can go a long way.

Increased monitoring and borrower communication can be strenuous on lenders who are already stretched thin; strategically using technology can help ease this burden. Consider leveraging relationship aggregation tools that can provide more transparency into borrower relationships, or workflow tools that can send automatic reminders of which borrower to check in with and when. Banks can also use automated systems to conduct annual reviews of customers whose loans are at risk. Technology can support lenders by organizing borrower information and making it more accessible. This allows lenders to be more proactive and better support borrowers who are struggling.

Technology is also a valuable tool once loans is classified as special assets. Many banks still use manual, paper-based processes to accomplish time consuming tasks like running queries, filling out spreadsheets and writing monthly narratives.

While necessary for managing special assets, these processes can be cumbersome, inefficient and prone to error even during the best of times — let alone during a potential downturn, a period with little room for error. Banks can use technology to implement workflows that leverage reliable data and automate processes based directly on metrics, policies and configurations to help make downgraded loan management more efficient and accurate.

Fluctuating economic conditions can impact a borrower’s ability to maintain solid credit quality. Every institution has their own criteria for determining what classifies a loan as a special asset, like risk ratings, dollar amounts, days past due and accrual versus nonaccrual. Executives should make time to carefully consider evaluating their current criteria and determine if these rules should be modified to catch red flags sooner. Early action can make a world of difference.

Community banks have long been known for their dependability; in today’s uncertain economic landscape, customers will look to them for support more than ever. Through strategically leveraging technology to make processes more accurate and prioritizing the management of special assets, banks can keep a closer pulse on borrowers’ loans and remain resilient during tough times. While bankers can’t stop a recession, they can better insulate themselves and their customers against one.

Fee Income at Premium as Crisis Threatens Credit

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Companies today have to work smarter and harder to survive the coronavirus crisis, said Green Dot Corp. CEO Daniel Henry in the company’s recent earnings call.

Henry joined Pasadena, California-based Green Dot as CEO on March 26, and has been working remotely to get up to speed on the $3 billion financial company’s operations, which include prepaid cards, tax processing and a banking platform. Those diversified business lines are a source of strength, he said.

“We’re in a much better position than just kind of a monoline neo-bank to weather the storm,” he says. “We’ve got positive free cash flows, strong revenues and cash in the bank.”

After a couple of years of moderately rising interest rates, the Federal Reserve began to back off mid-2019. They dramatically dropped them to zero in February as one tool to fight the economic downturn caused by the Covid-19 pandemic and have promised to keep them low until the economy shows firm signs of recovery. Now, it looks like the industry needs to strap in for another lengthy period of low interest rates.

All this puts further pressure on already-squeezed net interest margins.

While the spread between deposits and loans represents a bank’s traditional method of generating revenue, banks also focus on fee income sources to drive profitability. Business lines that expand non-interest income opportunities could be particularly valuable in the current environment.

With this in mind, Bank Director ranked publicly traded institutions based on noninterest income as a percentage of net income, using year-end 2019 data from S&P Global Market Intelligence. We focused on profitable retail banks with a return on average assets exceeding 1.3%.

Many of these banks rely on traditional sources of noninterest income — mortgages, insurance, asset management — but two differentiate themselves through unique business models.

Green Dot topped the ranking, with the bulk of its fees generated through prepaid card transactions. It also earns revenue through its Banking-as-a-Service arrangements with companies such as Uber Technologies, Apple, Intuit and long-term partner Walmart.

Meta Financial Group deploys a similar model, offering prepaid cards and tax products. The Sioux Falls, South Dakota-based bank will soon issue federal stimulus payments via prepaid cards to almost four million Americans through a partnership with the U.S. Treasury.

The remaining banks in our list take a more traditional approach.

Institutions like Dallas-based Hilltop Holdings primarily generate fee income through mortgage lending. Keefe, Bruyette & Wood’s managing director Brady Gailey believes the low-rate environment will favor similar financial institutions. “Hilltop has a very strong mortgage operation … which should do even better this year, given the lower rate backdrop that we have now,” he says.

The $15.7 billion bank announced the sale of its insurance unit, National Lloyds Corp., earlier this year; that deal is expected to close in the second quarter. Even without its insurance division, Hilltop maintains diverse fee income streams, says Gailey, through mortgage, investment banking (HilltopSecurities) and commercial banking.

Hilltop CEO Jeremy Ford said in a January earnings call that the insurance business wasn’t “core. … this will allow us to really focus more on those three businesses and grow them.”

As the fifth-largest insurance broker in the U.S., Charlotte, North Carolina-based Truist Financial Corp. enjoys operating leverage and pricing power, according to Christopher Marinac, the director of research at Janney Montgomery Scott. “[Insurance will] be a key piece of that income stream,” he says. “I think insurance is going to be something that every bank wishes they had — but Truist truly does have it, and I think you’re going to see them take advantage of that.”

In Green Dot’s earnings call, Henry said he’s still evaluating the company’s various business lines. But with Covid-19 pushing consumers to dramatically increase their use of electronic payment methods — both for online shopping and more hygienic in-person transactions — he’s bullish on payments.

“Covid is really forcing a lot of consumers [to] search out a digital solution,” Henry said. Visa recently reported that while face-to-face transactions declined significantly in April, there was an 18% uptick in digital commerce spending.

Recently, Green Dot investigated a spike in card sales in a particular area. It turned out that a local cable company’s offices were closed due to Covid-19. A sign on the company’s door instructed customers wanting to make in-person payments to go to a store across the street and buy a Green Dot card so they could make their payment electronically.

“A lot of the consumers that were hanging on to cash over the last few months really didn’t have an option and got pushed into the electronic payments world,” he said. “That will definitely benefit us at Green Dot.”

 

Top Fee Income Generators

Rank Bank Name Ticker Primary Fee Income Source Total Noninterest Income ($000s), YE 2019
#1 Green Dot Corp. GDOT Card $1,071,063
#2 Hilltop Holdings HTH Mortgage $1,206,974
#3 Waterstone Financial WSBF Mortgage $129,099
#4 HarborOne Bancorp HONE Mortgage $59,411
#5 Meta Financial Group CASH Card $221,760
#6 Truist Financial Corp. TFC Insurance $5,337,000
#7 FB Financial Corp. FBK Mortgage $135,038
#8 JPMorgan Chase & Co. JPM Asset management $58,456,000
#9 PNC Financial Services Group PNC Corporate services $7,817,138
#10 U.S. Bancorp USB Payments $9,761,000

Sources: S&P Global Market Intelligence, bank 10-Ks

Three Ways Directors Can Solve the 3,000-Year-Old Credit Problem

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credit-7-9-19.pngHistory has shown that knowledge is power. One place that could use the benefit of that knowledge is commercial credit.

Banks have been lending to businesses for 3,000 years and has yet to figure out the commercial credit process. But executives and directors have an opportunity to fix this problem using data and digital capabilities to make the process more efficient and faster, and become the lending legends of their institutions.

In 1300 B.C. Egypt, the credit process looked something like this: A seafaring trader would trade bronze bowls with a local bronze merchant for cloth and garments. But to make this transaction, the bronze merchant would need to borrow from multiple merchant lenders. This process required lenders to understand the business plans of the borrower, go “door to door,” have community knowledge and know the value of all those goods. There were a lot of moving pieces—and a great deal of time—involved for that one transaction.

Fast-forward to today. A lot has changed in 3,000 years, but the commercial credit process has actually gone backwards. It can take a lender 60 to 90 days and more than $10,000 per lead to identify potential leads—and that’s before they review the application. After a borrower applies, the lender must look up credit reports, collect and spread financial statements and decide on the terms and conditions. Finally, the application goes through the credit department, which can take another 30 to 45 days and cost $5,000 per application.

Lenders will have spent all that time and effort to process the loan—but may not end up with a new customer to show for it. Meanwhile, borrowers will have spent time and effort to apply and wait—and may not have a loan to show for it.

While this problem has persisted for 3,000 years, the good news is that executives and directors have an opportunity to fix the problem by turning their manual-lending process into a digital-lending one. This evolution entails three steps that transform the current process from weeks of work into days.

First, a bank would use a digital-lending portal to gather applicable demographics to identify prospective borrowers. In researching prospects, they see critical borrower information such as name, address, years in business, legal structure, taxpayer identification number, history, business description and management team. Rather than having to wait until later in the process to uncover this critical information, they can immediately identify whether to pursue this lead and quickly move on.

Second, a bank uses a credit-decision engine to gather and analyze the applicable borrower data. Not only can the engine pull in consumer and credit bureau information, but it can also include automated financial collection, credit score and industry data for comparison. The bank can use data from this tool to determine terms and conditions, credit structure, purpose of credit facility, pricing, relationship models and cross-sell strategies.

Third and finally, the bank’s credit policy and process integrate with its credit-decision engine to enable an automated review of a loan application. This would include compliance checks, terms and conditions and credit structure. Since the data gathering and analysis has already taken place and automatically factored into the decision, there is no need to review all those pieces, as would be required with a manual process.

These three steps of this digital lending process have distilled a weeks-long process into about five days. Executives and directors can not only grow their institution in a shortened time period; they can do so without adding any risk. A bank I worked with that had $250 million in assets was able to add $20 million in loan volume without taking on any additional risk.

By using knowledge to their advantage and implementing a digital lending solution, bankers can save not just time and costs, but their institutions as well as their communities. They can now spend their limited time and resources where they matter most: growing relationships along with their banks. Having fixed the 3,000-year-old credit problem, they can place those challenges firmly in the past and focus on their future.