Banks Ignore Credit Administration at Their Peril

Not long ago, I asked the CEO of a mid-sized bank how he makes funding decisions when looking to add new technology or software systems. He told me that when it comes to spending money on software, he only listens to two people: the CEOs of other banks, and “Whatever my chief lending officer says.”

The question that immediately popped into my head was, “Why doesn’t the chief credit officer have a say?”

This situation is not unique. For a long time, credit administration has taken somewhat of a back seat when it comes to resource prioritization within banks. But this mindset can be dangerous for banks; if executives don’t give credit administrators the budget they need, it can come back to bite their institutions in several ways. Bankers would be wise to take a second look at how they allocate resources and consider three reasons why credit administration should be a bigger priority.

The resource disparity
It’s not hard to understand why credit administration can sometimes get overlooked. The lending side of the house gets the most investment because it brings in the revenue. When push comes to shove, the money makers are the ones who will receive the most attention from management.

It’s not as if credit administrators have been completely forgotten: Bank CEOs usually understand the importance of managing the loan portfolio. But the group often doesn’t receive funding priority, while it often feels like the lending team has a blank check. Credit administration is just as important as loan production; closing the resource gap can decrease risk and increase efficiency for your bank.

Limiting credit risk
The biggest reason banks should invest more in their credit administration department is risk mitigation. When credit administration systems are ignored, spreadsheets can run rampant. This opens the door to numerous risks and errors, including criticism from auditors and examiners.

Outdated systems can open your bank up to risk because administrators are unable to gather and analyze data in a coherent way. They are left using multiple systems and spreadsheets to create a complete view of a loan — a fragmented process that makes it easy to miss important risk indicators. Credit administrators require powerful tools that increase a loan’s visibility, not limit it. To mitigate risk, banks should invest in systems that make it easier for credit administrators to see the complete picture in one place.

Increasing operational efficiency
Investing in credit administration also improves operational efficiency for your bank’s employees. Clunky, outdated systems impede credit administrators from accessing important information in succinct ways. Fumbling through multiple systems and screens to find key data points increases the time it takes to perform even the most routine tasks. Performing a simple data extraction will often involve IT, wasting multiple employees’ time. What could be a simple and straightforward loan review process has turned to a slow, cumbersome and ultimately expensive process.

Outdated software can also negatively impact your team’s overall job satisfaction. Poorly designed systems can be frustrating to use; upgrading other departments’ systems could create a perception that credit administrators aren’t valued by the organization. This could hurt your company culture and lead to costly turnover down the road. Investing in new software and giving credit administrators tools that make their jobs faster and easier is a way that banks can demonstrate their support, keep employees happy and improve the efficiency of their work — potentially improving overall profitability.

Credit administration and loan production are two sides of the same coin, but resources have been weighted significantly toward the lenders for too long. It’s time for a change. Reassessing how your bank can support its credit administration team can mitigate risk, improve operations and ultimately save your bank money.

The Keystone Trait of Prudent and Profitable Banking

The more you study banking, the more you realize that succeeding in the industry boils down to a handful of factors, the most important of which is efficiency.

This seems obvious, but it’s worth exploring exactly why efficiency is so critical.

A bank, at its core, is a highly leveraged fund, with the typical bank borrowing $10 for every $1 worth of capital. This makes banks profitable. However, it also means that banks, by design, are incredibly fragile institutions, using three times as much debt as the typical company.

Warren Buffett wrote about this in his 1990 letter to shareholders:

The banking business is no favorite of ours. When assets are twenty times equity — a common ratio in this industry — mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks.

The primary source of mistakes in banking, Buffett noted, is what he refers to as the institutional imperative, “the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”

Buffett was writing about a commercial real estate crisis in the early 1990s that was laying waste to the banking industry. As competition for commercial loans heated up, banks cut rates and eased terms in order to win business. When real estate prices crashed, banks paid the price for doing so.

It was during that time, for instance, that Security Pacific Corp., one of the great California banking dynasties, sold itself to BankAmerica Corp. to stave off insolvency.

These pressures — the fear of missing out, if you will — have not gone away. They factored into the financial crisis, causing lenders to move down the credit ladder in order to make subprime loans. And the word on the street is that these same pressures are causing some banks to cut rates and ease lending terms today.

The key is to insulate yourself from these pressures.

Part of this is psychological — understanding how emotions, particularly fear and greed, play into decision making. And part of it is practical — operating so efficiently that it eliminates the temptation to boost profitability by easing credit standards.

The direct role of efficiency in a bank’s operations is obvious: The less revenue a bank spends on expenses, the more that’s left over to fall to the bottom line.

But the indirect role of efficiency is even more important: A bank that operates efficiently can relinquish some of its margin to attract the highest-quality credits. It also eliminates the need to stretch on credit quality in order to earn one’s cost of capital — a return on equity of between 10% and 12%.

“Being a low-cost provider gives one a tremendous strategic advantage,” Jerry Grundhofer, the former chairman and CEO of U.S. Bancorp, once told Bank Director’s Jack Milligan. “It allows you to deal with challenges, be competitive on the asset and liability sides of the balance sheet and take care of customers.”

Indeed, it’s no coincidence that the most efficient banks when it comes to operations also tend to be the most prudent when it comes to risk management.

But not all efficiency is created equal. In banking, efficiency is expressed as a ratio of expenses to revenue. The key is to have the right mix of the two.

The temptation is to drive efficiency through cost control. The problem with doing so, however, is that a bank can only lower its costs so far before it begins to cannibalize its business.

The same isn’t true of revenue, which tends to be twice as large as expenses. Consequently, the most efficient banks through time generally are those with the highest revenue to assets, not the highest expenses to assets.

The archetype for a high-performing bank isn’t just one that operates efficiently, but one that drives its efficiency through revenue, the denominator in the efficiency ratio.

An Easy Way to Lose Sight of Critical Risks


audit-6-7-19.pngLet me ask you a question…

How does the executive team at your biggest competitor think about their future? Are they fixated on asset growth or loan quality? Gathering low-cost deposits? Improving their technology to accelerate the digital delivery of new products? Finding and training new talent?

The answers don’t need to be immediate or precise. But we tend to fixate on the issues in front of us and ignore what’s happening right outside our door, even if the latter issues are just as important.

Yet, any leader worth their weight in stock certificates will say that taking the time to dig into and learn about other businesses, even those in unrelated industries, is time well spent.

Regular readers of Bank Director know that executives and experienced outside directors prize efficiency, prudence and smart capital allocation in their bank’s dealings.

But here’s the thing: Your biggest—and most formidable—competitors strive for the same objectives.

So when we talk about trending topics at this year’s Bank Audit and Risk Committees Conference, hosted by Bank Director in Chicago from June 10-12, we do so with an eye not just to the internal challenges faced by your institution but on the external pressures as well.

As we prepare to host 317 women and men from banks across the country, let me state the obvious: Risk is no stranger to a bank’s officers or directors. Indeed, the core business of banking revolves around risk management—interest rate risk, credit risk, operational risk.

Given this, few would dispute the importance of the audit committee to appraise a bank’s business practices, or of the risk committee to identify potential hazards that could imperil an institution.

Banks must stay vigilant, even as they struggle to respond to the demands of the digital revolution and heightened customer expectations. I can’t overstate the importance of audit and risk committees keeping pace with the disruptive technological transformation of the industry.

That transformation is creating an emergent banking model, according to Frank Rotman, a founding partner of venture capital firm QED Investors. This new model focuses banks on increasing engagement, collecting data and offering precisely targeted solutions to their customers.

If that’s the case—given the current state of innovation, digital transformation and the re-imagination of business processes—is it any wonder that boards are struggling to focus on risk management and the bank’s internal control environment?

When was the last time the audit committee at your bank revisited the list of items that appeared on the meeting agenda or evaluated how the committee spends its time? From my vantage point, now might be an ideal time for audit committees to sharpen the focus of their institutions on the cultures they prize, the ethics they value and the processes they need to ensure compliance.

And for risk committee members, national economic uncertainty—given the political rhetoric from Washington and trade tensions with U.S. global economic partners, especially China—has to be on your radar. Many economists expect an economic recession by June 2020. Is your bank prepared for that?

Bank leadership teams must monitor technological advances, cybersecurity concerns and an ever-evolving set of customer and investor expectations. But other issues can’t be ignored either.

At our upcoming event in Chicago, the Bank Audit and Risk Committees Conference, I encourage everyone to remember that minds are like parachutes. In the immortal words of musician Frank Zappa: “It doesn’t work if it is not open.”

Five Reasons Behind Mortgage Subservicing’s Continued Popularity


mortgage-6-3-19.pngMortgage subservicing has made significant in-roads among banks, as more institutions decide to outsource the function to strategic partners.

In 1990, virtually no financial institution outsourced their residential mortgage servicing.

By the end of 2018, the Federal Reserve said that $2.47 trillion of the $10.337 trillion, or 24%, of mortgage loans and mortgage servicing rights were subserviced. Less than three decades have passed, but the work required to service a mortgage effectively has completely changed. Five trends have been at work pushing an increasing number of banks to shift to a strategic partner for mortgage subservicing.

  1. Gain strategic flexibility. Servicing operations carry high fixed costs that are cannot adapt quickly when market conditions change. Partnering with a subservicer allows lenders to scale their mortgage portfolio, expand their geographies, add product types and sell to multiple investors as needed. A partnership gives bank management teams the ability to react faster to changing conditions and manage their operations more strategically.
  2. Prioritizes strong compliance. The increasing complexity of the regulatory environment puts tremendous strain on management and servicing teams. This can mean that mortgage businesses are sometimes unable to make strategic adjustments because the bank lacks the regulatory expertise needed. But subservicers can leverage their scale to hire the necessary talent to ensure compliance with all federal, state, municipal and government sponsored entity and agency requirements.
  3. Increased efficiency, yielding better results with better data. Mortgage servicing is a data-intensive endeavor, with information often residing in outdated and siloed systems. Mortgage subservicers can provide a bank management team with all the information they would need to operate their business as effectively and efficiently as possible.
  4. Give borrowers the experience they want. Today’s borrowers expect their mortgage lender to offer comparable experiences across digital channels like mobile, web, virtual and video. But it often does not make sense for banks to build these mortgage-specific technologies themselves, given high costs, a lack of expertise and gaps in standard core banking platforms for specific mortgage functions. Partnering with a mortgage subservicer allows banks to offer modern and relevant digital servicing applications.
  5. Reduced cost. Calculating the cost to service a loan can be a challenging undertaking for a bank due to multiple business units sharing services, misallocated overhead charges and hybrid roles in many servicing operations. These costs can be difficult to calculate, and the expense varies widely based on the type of loans, size of portfolio and the credit quality. A subservicer can help solidify a predictable expense for a bank that is generally more cost efficient compared to operating a full mortgage servicing unit.

The broader economic trends underpinning the growing popularity of mortgage subservicing look to be strengthening, which will only accelerate this trend. Once an operational cost save, mortgage subservicing has transformed into a strategic choice for many banks.

Five Critical Mistakes to Avoid in Any Headquarters Project


headquarters-5-15-19.pngCorporate headquarter projects are likely one of the biggest investments a bank will make in itself.

With a lot of time and money on the line, it is no surprise that these massive projects quickly become an area of major stress for executives. Most management teams have limited experience in executing projects of this kind. The stakes are high. Bad workplace design costs U.S. businesses at least $330 billion annually in lost efficiency, productivity and overall employee engagement, according to Facility Executive.

A lot can go wrong when planning a corporate headquarters. Executives should use a data-based approach and address these issues in order to avoid five critical oversights:

1. Overpromising and Under-delivering to the Board
You should feel confident that every decision for your planned headquarters is the right one. The last thing you want to do after you get the board’s approval on the size, budget and completion date for the project is go back for more money and time because of educated guesses or bad estimates.

Avoiding this comes down to how you approach the project. Select a design-build firm that considers your needs and asks about historical and projected growth, trends and amenities, among other issues. This will help mitigate risk and create a plan, budget and timeline based on research and deliberation

2. Miscommunication Between Design and Construction
Partnering with a design-build firm helps alleviate the potential for miscommunication and costly changes between architects and construction crews. Look for firms with a full understanding of costs, locally available resources and current rates, so they can design with a budget in mind. Some firms offer a guaranteed maximum price on a project that can eliminate surprises. 

3. Missing the Mark on Efficiencies and Adjacencies
The way employees work individually and collaborate with others is changing. Growing demand for work areas like increased “focus spaces,” more intimate conference rooms and other amenities should not to be ignored. Forgetting to consider which departments should be next to each other to foster efficiency is also an oversight that could dampen your bank’s overall return. Look for a firm that has an understanding of banking and how adjacencies can play a role in efficiency that can guide you toward which trends are right for your bank.

4. Outgrowing the New Space too Soon
I have witnessed a project that was not properly planned, and the board was asked to fund another project for a new, larger building only five years after the first one. As you can probably imagine, the next project is being watched and scrutinized at every turn.

Most architectural designers will ask you what you want and may look at whatever historical data you provide. Beyond that, how will you know if the building will last? A good design-build firm should incorporate trends from the financial industry into your design; a great one will provide you with data, projected growth patterns and research, so you can demonstrate to the board that the bank is making the right investment and that the new space will last.

5. Forgetting the People Piece
Not communicating with your employees or leadership on the reasons behind the change or how to use the new space often means leaving money and happiness on the table. The design and the features of the building frame the company culture, but the people complete the picture.

Make sure to show your workforce the purpose of the new space. Help get everyone excited and on the same page with the use, process and procedures. Do not drop the ball after the hard work of building the headquarters.

When it comes to any project—especially one of this size and magnitude—always measure twice and cut once.

Exclusive: How U.S. Bancorp Views Expansion


bancorp-3-14-19.pngGreat leaders are eager to learn from others, even their competitors. That’s why Bank Director is making available—exclusively to our members—the unabridged transcripts of the in-depth conversations our writers have with the executives of top-performing banks.

Few banks fit this description as well as U.S. Bancorp, the fifth-largest retail bank in the United States. It has generated one of the most consistently superior performances in the banking industry over the past decade. It’s the most profitable and efficient bank among superregional and national banks. It’s the highest-rated bank by Moody’s. It’s also been named one of the world’s most ethical companies for five years in a row by the Ethisphere Institute. And it has emerged as a leader of the digital banking revolution.

Bank Director’s executive editor, John J. Maxfield, interviewed U.S. Bancorp Chairman and CEO Andy Cecere for the first quarter 2019 issue of Bank Director magazine. (You can read that story, “Growth Through Digital Banking, Not M&A,” by clicking here.)

In the interview, Cecere sheds light on U.S. Bancorp’s:

  • Strategy for expanding into new markets
  • Progress on the digital banking front
  • Perspective on the changes underway in banking
  • Experience through the financial crisis

The interview has been edited for brevity, clarity and flow.

download.png Download transcript for the full exclusive interview

Driving Profitability by Keeping Score


profitability-2-19-18.pngTwo thousand and seventeen proved to be a pretty good year for banks, and 2018 promises to be even better. While the economic environment of lower taxes, rising rates and promises of deregulation have driven up valuations, the secret sauce that produces results still eludes many. The answer lies deep within banks and can be realized by implementing balanced scorecards throughout that hold people accountable for performance and provide targets for success that drive the bottom line.

Developing benchmarks by individual business lines to enforce accountability can help them improve their staffing, processes and strategies, and often exposes low performers and manual processes that negatively impact profitability. Although this seems logical, in practice few banks have had success in figuring out these scorecards.

The following best practice tips will help in creating these metrics, setting appropriate goals and designing an effective overall performance management strategy.

Keep it Simple: Every department should be working with five to seven (not 20) easy-to-track metrics. Too much detail can cause confusion as well as create more work than it’s worth to calculate. For example, tracking the average time customers wait in line in branches is next to impossible and non-productive, but tracking call center hold times is much easier and most likely exists in a canned report today.

Take a Balanced Approach: A mixture of efficiency, quality and risk benchmarks provides a good balance. The following example of a balanced scorecard in mortgage lending illustrates risk metrics including approval rates, average credit score, client service metrics for turnaround times and efficiency metrics for production of loan officers, processors and underwriters.

metric-chart.pngFocus on the Outliers: Tracking performance is only the first step in developing a scorecard system. As the performance culture matures and as data trends become clearer, identifying outliers and improving performance in those areas is the key. Becoming a high performer sometimes means changing an underlying process or technology. But it can also come down to one or two individuals who are driving either high or low performance. Digging in to understand those variants can pay significant dividends. For example, in our sample scorecard, one loan officer was doing 15 loans per month while others were doing three to four.

While compensation structure can account for some of this variance, the opportunity cost to get those lower performers up to at least average can be significant. It turns out that the officer doing 15 loans per month had reached out to marketing for lists of clients new to the bank that had mortgages at other institutions and was cross-selling those in his market while the others had no idea the information was available.

When it comes to revenue generation, most banks have squeezed expenses and capitalized on the low-hanging fruit. The next step is to drive the bottom line through well-thought-out business line scorecards that produce actionable data to improve performance. The goal is to use these key performance indicators to drive better processes, strong customer service, less risk and higher returns to shareholders.

Banks Can Banish Paper Waste and Inefficiency


11-7-2014-Hyland.jpgIf banks want to realize material gains in performance, they must learn to work differently. Until they commit to drastically changing their processes by going paperless, scale will be elusive and service levels will drift in a state of costly inefficiency.

Tellingly, 58 percent of people said they believe half or less of the work in their shops is “real” work, according to a survey recently conducted by Cornerstone Advisors. Real work is valuable. The rest, the non-work activity, is waste.

Unbelievable, right? The intense cost, revenue and compliance pressures the financial services industry is facing today means that banks must seek to optimize their processes to eliminate the waste.

Here are three ways to get back to basics and banish the waste.

Identify and own the process
Process design is the key to eliminating waste. However, the challenge is that processes can span across the organization and even cross organizational boundaries.

“A first step in changing the way we work is to have one person in charge of the process—the entire process, not just certain tasks within the process,” says Michael Croal, Cornerstone’s senior director.

To effect the changes necessary to eliminate this waste requires effort and a leader. And the key to success is making sure that leader has a thorough understanding of what the process must accomplish—across the entire enterprise, if applicable.

Redesign for maximized performance
The paralysis-by-analysis trap often catches process improvement teams. Too much time is spent and too much momentum is lost analyzing and documenting the way the process performs. This leads to ineffective process improvement programs.

Instead, try to determine what the result of the process needs to be. Don’t just continue to do things a certain way because they have always been done that way.

Remember what Einstein said: “Insanity is doing the same thing over and over and expecting different results.”

Led by the process owner, an effective process improvement program will include:

  • A senior executive that believes in and publicly supports the initiative
  • Dedicated resources focused on process analysis, process design and change management
  • Metrics to identify issues and drive improvements
  • A training program designed for the process and executed to ensure employees are fully trained

Harness the power of technology
As financial institutions begin to redesign their processes, they must realize that these processes have been passed down over years and even changes of leadership. While the technology that supports the processes may have also changed, it is unlikely that the process has ever been engineered for maximum performance from start to finish, leaving expensive technology implementations to be miserably underutilized or incorrectly used.

Technology adds little value if it is not implemented with process performance in mind. It’s also crucial to evaluate the technology used in the process.

For example, most banks own at least one enterprise content management (ECM) system. However, many implementations are not only underutilized, but they’re also incorrectly used. Historically, most financial institutions looked at ECM as a tool just for imaging and reclaiming storage costs by digitizing documents. But there is so much more that they can do than simply scanning, storing and retrieving signature cards and loan applications.

With ECM, banks can automate virtually any manual, time-consuming process in a paper-based world. No more lost or misfiled documents. No more shipping paper loan files between offices. No more worrying about locating documents during an audit.

Banks should view ECM as a technology to leverage across the entire financial institution to automate and streamline processes—from loan origination to new employee onboarding. If an institution has already invested in an ECM solution, the next step is to explore how to leverage the existing technology across the enterprise, including human resources and accounting departments.

ECM is just one technology example that can drastically change the way you work. Until banks commit to drastically changing their processes across the enterprise, service levels will float in a state of costly inefficiency and future growth initiatives will become unrealistic. Banishing the waste is critical for the future of the organization.

And the first step is to stop depending on paper.

Efficiency and Its Impact


11-25-13-Hovde.pngThe banking industry is consolidating. This is not shocking news to most people. The number of financial institutions in the U.S. has declined from 15,158 in 1990 to 6,940 as of June 30, 2013, according to the Federal Deposit Insurance Corp. Not a single de novo institution has been approved in more than two years. This is astonishing considering 144 were chartered in 2007 alone. However, a look below the surface is required to get a better understanding of bank consolidation and how it is reshaping the industry.

The economics of the banking business have changed. Discussions about increased regulatory burdens and higher capital requirements have been common during the past few years. We believe the financial impacts of producing an acceptable return to shareholders in spite of these challenges will continue to be an integral theme in the banking industry. Earnings from traditional spread income are under pressure for most banks due to a prolonged low interest rate environment (especially for those banks without a robust lending team to generate loans with good yields). Furthermore, increased regulation and compliance requirements have driven up fixed operating costs. These factors, collectively, have resulted in lower returns on tangible common equity for shareholders—arguably the most important measure of profitability from an investor’s perspective.

To adjust to the changing regulatory and operating environment, bankers are looking for strategies to cope with these challenges. With margins under pressure and increased fixed operating costs, many bankers are looking to achieve economies of scale and utilize more technology to manage more earning assets and more cheap liabilities per dollar of operating expense. While there are many strategies to pursue to improve shareholder returns in a challenging operating environment, empirical evidence shows that focusing on efficiency is certainly an effective strategy. Below is a chart illustrating the stock prices of publicly traded banks with assets of between $1 and $25 billion with efficiency ratios in the third quarter of 2013 in excess of 80 percent (we’ll call those inefficient banks) and those with efficiency ratios below 60 percent (we’ll call those efficient banks). Although 2013 has been a good year for bank stocks overall; the stock prices of efficient banks have increased by nearly 40 percent on average, while inefficient banks have only increased by 17 percent on average. Simply put, efficient banks have bested the market while inefficient banks have lagged behind.

The efficient banks have stronger earnings (averaging more than a 12 percent return on tangible shareholders’ equity versus 5 percent for inefficient banks). Currently, inefficient banks are trading at an average price-to-tangible book ratio of 113 percent versus 190 percent for the efficient banks group. Having a stronger currency (e.g., a stock trading at a higher multiple) is an advantage when structuring a merger; it allows the transaction to be more accretive (or less dilutive) to tangible book value per share for an acquirer when stock is used as consideration. Thus, efficient banks also have an advantage in pursuing acquisitions over the inefficient banks.

This leads to our next point: During the past year, 74 percent of public buyers have seen their stock prices appreciate during the month following the announcement of an acquisition. Additionally, buyers that have announced deals representing about 10 percent or greater of the buyer’s pro forma assets have seen their stock prices appreciate 8.4 percent on average during the next 90 days post-announcement. In short, the market has been rewarding buyers for pursuing efficiency through size and scale. While a deal can make sense if it has financial merit alone, it is truly great if there is a combination of strategic and financial rationale.

The industry is in the best shape in five years and continues to strengthen. Stressed and troubled institutions are being placed in the hands of strong, capable buyers. The number of failed banks has declined from 157 in 2010 to only 23 during the first 10 months of 2013. The landscape is changing from an environment dominated by FDIC-assisted deals and open-bank acquisitions of stressed banks to a much healthier M&A landscape. While buyers have been rewarded for pursuing accretive FDIC-assisted transactions, they are now also being rewarded for paying a fair premium for high-quality community banks that offer strategic value and make financial sense. The industry dynamics today are ripe for continued consolidation. The efficiencies gained through strategic M&A will continue to be noticed and appreciated by bank shareholders.