Unlocking the Potential of Small Business Lending

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Community banks have long played a pivotal role in supporting small businesses, providing the necessary capital for local entrepreneurs growing or expanding their ventures. It is estimated that community banks account for approximately 60% of small business loans, according to the Independent Community Bankers of America.

Despite their essential role, many community banks still operate with traditional, manual processes, missing out on the efficiency-enhancing benefits of technology. Approximately 80% of community banks with assets under $5 billion do not utilize a commercial loan origination system provider. However, embracing technology can be a game-changer for community banks looking to reduce lending costs, enhance efficiency and expedite the delivery of capital to small businesses.

One of the key factors in small business lending is speed. For small and medium-sized businesses, or SMBs, efficient access to capital can often have a dramatic impact on operations. These businesses often manage their cash flow strategically; delays in securing funding can have serious consequences. The time from application to funding is critical for SMBs, meaning community banks must continue finding ways to reduce this end-to-end turn time.

While the traditional relationship-based model of community banking remains invaluable, integrating technology into lending processes can be a win-win for both banks and their customers. Here are three steps that community banks should consider to drive efficiencies in their lending processes, even if they are not yet ready for a full-scale commercial lending platform.

1. Consult Your Team
The first step in any innovation journey is to consult your bank’s internal experts. Engage your lending and credit teams to identify pain points in the lending process and how technology and automation could alleviate these challenges and enhance efficiency. Often, those on the front lines of lending have valuable insights into where improvements can and should be made.

2. Embrace Platforms
While a full-fledged loan origination system may not be immediately necessary for your institution, community banks can benefit from platforms that streamline the financial document collection process and client communication. These solutions can make it easier for customers to securely upload and submit their financial documents and communicate directly with the bank, which can simplify the initial stages of the lending process. These tools can have the added benefit of assisting credit teams in digesting and spreading financial data, reducing the time needed for manual data entry and analysis. This accelerates the lending turnaround time and provides a better overall experience for customers.

3. Augment Your Credit Teams
We often see the main challenge for banks trying to speed up the lending process isn’t the technology but their resource constraints. During periods of staffing shortages or high demand for loans, community banks can consider leveraging external pools of subject matter experts to supplement their in-house teams. These experts can help banks expedite lending decisions, providing the necessary labor around financial spreading and the resulting narratives, which can help ensure that businesses get the capital they need promptly.

Community banks are the lifeblood of many small businesses, offering not only financial support but also personalized service and relationships. While the traditional community banking model remains vital, embracing new technology and innovative solutions is essential to meet the evolving needs of small businesses. By taking these steps to improve lending processes and reduce turnaround times, community banks can continue to serve as crucial partners for small and medium businesses, helping them thrive and contribute to local economies.

The Big Debate: Should Bank Boards Approve Loans?

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A majority of banks approve individual loans at the board level, but should they?  

Bank Director’s 2023 Governance Best Practices Survey indicates that while the practice remains common, fewer boards approve individual loans compared to just a few years ago. Sixty-four percent of responding directors and CEOs say their board approves individual loans, either as a whole or via a board-level committee, while 36% say the board approves loan policies or limits. Four years ago, 77% of respondents to Bank Director’s 2019 Risk Survey said their board approved individual loans.

In an environment that’s characterized by economic uncertainty and sluggish loan demand, does this additional layer of review create more risk? Or does it provide a level of assurance that the credit will hold up, should the economy tip into a recession? 

”There’s no firm rule that says a board should be or should not be involved in this decision,” says Brandon Koeser, a senior analyst at the consulting firm RSM US LLP. 

Boards at banks below $10 billion in assets are more likely to be directly involved in approving individual loans. Those loans may be less complex, and board members may be more likely to know the borrower’s character. While it’s valuable to have former lenders in the boardroom who can review loan packages, it can also help to include perspectives from directors with other types of business experience.  

“A lender is going to approach a loan differently than someone who may have been in the actual borrower’s shoes or may still be in a borrower’s shoes,” says Koeser. “They might even give management additional questions to think through when they’re going through that decision.”

Some bankers say the additional board oversight benefits their organization in other ways, by giving directors a clearer window into the risks and opportunities the bank faces. And while it may be more work for lenders, it also allows those bankers to look at the deal several times before it’s finalized. 

At Decatur County Bank, the $270 million subsidiary of Decatur Bancshares in Decaturville, Tennessee, the board approves individual loans over a certain size, says CEO Jay England. Many of the bank’s board members have at least a decade of experience in approving loans, and the board recently added a former banking regulator to its membership. Those directors’ collective experience provides valuable oversight for larger deals, he says.  

Lending has historically been one of the riskiest activities banks engage in and approving loans as a director carries some degree of risk itself. In the aftermath of the 2008 financial crisis, a number of bank directors and officers at failed banks were sued by the Federal Deposit Insurance Corp. for loans they had approved that later went bad. 

If directors could be held liable for bad loans, England says, they “should be getting a look at the decisions we’re making.” 

But that doesn’t mean there isn’t room for some improvement. The bank revamped its lending and approval process several years ago, he says. As part of that, it adopted a board portal. Bankers upload loan packages into that portal so board members can review them on their own time in between meetings. 

The $1.5 billion Cooperative Bank of Cape Cod moved away from loan approvals by the board as part of an overall shift toward an enterprise risk management structure, says Lisa Oliver, CEO and chair of the Hyannis, Massachusetts-based bank. It created an internal loan committee staffed by bank officers — including the chief credit officer, chief risk officer, chief financial officer and chief strategy officer, along with Oliver as CEO — to approve credits and undertake a deeper analysis of the bank’s credit portfolios, trends, policies and risk tolerances.  

At the board level, the bank folded its loan, finance and IT committee functions into one enterprise risk management committee. That committee’s responsibilities around credit include monitoring portfolios for concentration risk, and reviewing each of the bank’s lending areas for trends in delinquencies, nonaccrual rates and net charge-offs. 

Loans up to $2.5 million are approved by the bank’s chief credit officer. Loan relationships over $2.5 million are sent to the bank’s internal loan committee for approval, and relationships over 15% of the bank’s total capital move to the board for ratification, says Oliver. In this context, the committee isn’t digging into the merits of a deal to approve a specific credit. Rather, the board sees an executive summary of the loan to evaluate its impact on concentration risk limits, risk rating levels and construction loan limits. 

Reading one single loan package can take 45 minutes to an hour for a seasoned credit professional, and Oliver says that moving to this structure has freed up board members’ time and resources to focus on the larger picture of risk management and strategy. 

“Everyone’s time is valuable. I don’t want my board to have to spend time reading these deals,” Oliver says. “What I need to do is elevate them out of management, which is really approving loans, and get them into their seat as risk oversight: approving policies, understanding trends, looking at concentrations and developing risk appetites.” 

Governance issues like these will be covered during Bank Director’s Bank Board Training Forum in Nashville Sept. 11-12, 2023.

Article updated on Sept. 15, 2023, to clarify approvals at Cooperative Bank of Cape Cod.

Automating Back-of-House Lending Processes to Unlock Efficiency

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The banking industry has made strides in offering customers easier ways to sign, wherever and whenever they want. In fact, 95% of financial institutions plan to enhance their lending capabilities. As banks prioritize a single platform for digitized loan application, back-of-house automation becomes critical to delivering an experience that customers expect.

Think about the manual process it takes to move a loan through a bank. Now imagine that someone is on vacation, someone is in meetings all day or someone inadvertently forgets to pass the application to the next department. Not only do these cause delays in the application, but they are also labor-intensive to move forward. Embracing back-of-house automation helps banks minimize risks, enhance productivity, reduce costs and deepen the customer relationship.

The lending process involves intricate regulatory and compliance frameworks; failure to comply with these regulations can result in severe penalties and reputational damage. Manual processing carries the risk for errors and potential compliance breaches. Automated systems, on the other hand, can help banks ensure that they’re adhering to legal requirements, risk management protocols and regulatory guidelines, while freeing up team members to focus on the things that will actually deepen customer relationships. Incorporating back-of-house automation allows banks to maintain compliance and strengthen their overall risk management framework. The best part? It can be done automatically.

In today’s competitive landscape, focusing on customer experience is a table stakes priority. Manual lending processes often result in delays, errors and fragmented communication, making customers wonder if they are just another number to an institution. Banks can streamline the customer interactions that are truly table stakes and reduce turnaround times by automating their back-of-house lending processes. Automated systems can provide customers with self-service options and real-time updates on loan statuses, giving them a sense of transparency. This can lead to a seamless experience for them throughout the lending process, strengthening a bank’s customer loyalty and retention.

When Hughes Federal Credit Union automated its back-office loan processes, it drastically reduced its loan processing time from three weeks to 120 minutes. The $836 million credit union increased its indirect lending volume by 27% after implementing electronic signature solutions.

At the same time, banks can’t forget about the opportunity to transform their employee’s experience at the same time. Automation doesn’t reduce the need for employees. It empowers employees to do the job they were actually hired to do. Instead of dealing with manual steps needed to keep a loan moving, they can do their part and automatically send it to the next department before getting back to what matters most: deepening the customer relationship.

Automating back-of-house lending processes enables banks to achieve unparalleled operational efficiency. Manual tasks, such as document verification, data entry and loan application processing are time-consuming and prone to errors. Automation solutions can seamlessly integrate with existing systems and create role-based transaction management to make back-of-house systems easier. Automation reduces friction, wasted time, and eases the stress of managing people and document flow by creating rules and systems to move transactions through different departments effortlessly. Hughes Federal Credit Union saved nearly $107,000 annually by moving from a paper-based process to an electronic environment.

Almost all financial institutions plan to embed fintech into their digital banking experiences, which makes embracing automation not only a competitive advantage but a necessity. By embracing back-of-house automation, banks can minimize risks, achieve operational efficiency and enhance their customer experience, all while scaling their lending operations. As banks continue to navigate digital transformation, automation continues to be a key driver for success in lending.

As Interest Rates Rise, Loan Review Gets a Second Look

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In 1978, David Ruffin got his first mortgage. The rate was 12% and he thought it was a bargain.

Not many people who remember those days are working in the banking industry, and that’s a concern. Ruffin, who is 74 years old, still is combing through loan files as an independent loan reviewer and principal of IntelliCredit. And he has a stark warning for bankers who haven’t seen a rising interest rate environment, such as this one, in more than 40 years.

“Credit has more hair on it than you would want to acknowledge,” Ruffin said recently at Bank Director’s Bank Audit & Risk Conference. “This is the biggest challenge you’re going to have in the next two to three years.”

Borrowers may not be accustomed to higher rates, and many loans are set to reprice. An estimated $270.4 billion in commercial mortgages held at banks will mature in 2023, according to a recent report from the data and analytics firm Trepp.

Nowadays, credit risk is low on the list of concerns. The Office of the Comptroller of the Currency described credit risk as moderate in its latest semiannual risk perspective, but noted that signs of stress are increasing, for example, in some segments of commercial real estate. Asset quality on bank portfolios have been mostly pristine. In a poll of the audience at the conference, only 9% said credit was a concern, while 51% said liquidity was.

But several speakers at the conference tried to impress on attendees that risk is buried in loan portfolios. Loan review can help find that risk. Management and the board need to explore how risk can bubble up so they’re ready to manage it proactively and minimize losses, he said. “The most toxic thing you could fall victim to is too many credit surprises,” he said.

Some banks, especially smaller ones, outsource loan review to third parties or hire third parties to independently conduct loan reviews alongside in-house teams. Peter Cherpack, a partner and executive vice president of credit technology at Ardmore Banking Advisors, is one of those third-party reviewers. He says internal loan review departments could be even more useful than they currently are.

“Sometimes [they’re] not even respected by the bank,” he says. “It’s [like] death-and-taxes. If [loan reviewers are] not part of the process, and they’re not part of the strategy, then they’re not going to be very effective.”

Be Independent
He thinks loan review officers shouldn’t report to credit or lending chiefs; instead, they should report directly to the audit or risk committee. The board should be able to make sense of their conclusions, with highlights and summaries of major risks and meaningful conclusions. Their reports to the board shouldn’t be too long — fewer than 10 pages, for example — and they shouldn’t just summarize how much work got done.

Collaborate
Loan review should communicate and collaborate with departments such as lending to find out about risk inside individual industries or types of loans, Cherpack says. “They should be asking [the loan department]: ‘What do you see out there?’ That’s the partnership that’s part of the three lines of defense.”

He adds, “if all they’re doing is flipping files, and commenting on underwriting quality, that’s valuable, but it’s in no way as valuable as being a true line of defense, where you’re observing what’s going on in the marketplace, and tailoring your reviews for those kinds of emerging risks.”

Targeted Reviews
Many banks are stress testing their loan portfolios with rising rates. Cherpack suggests loan review use those results to adjust their reviews accordingly. For instance, is the bank seeing higher risk for stress in the multifamily loan portfolio? What about all commercial real estate loans that are set to reprice in the next six to 18 months?

“If [loan review is] not effective, you’re wasting money,” Cherpack says. “You’re wasting opportunity to protect the bank. And I think as, as a director, you have a responsibility to make sure the bank’s doing everything it should be doing to protect its shareholders and depositors.”

Carlyn Belczyk is the audit chair for the $1.6 billion Washington Financial Bank in Washington, Pennsylvania. She said the mutual bank brings in a third-party for loan review twice a year. But Cherpack’s presentation at the conference brought up interesting questions for her, including trends in loans with repricing interest rates or that were made with exceptions to the bank’s loan policy. “I’m fairly comfortable with our credit, our loan losses are minimal, and we probably err on the side of being too conservative,” she said.

Ruffin doesn’t think coming credit problems will be as pronounced as they were during the 2007-08 financial crisis, but he has some words of advice for bank boards: “Weak processes are a telltale sign of weaknesses in credit.” he said.

Historically, periods of high loan growth lead to the worst loan originations from a credit standpoint, Ruffin said.

“We do an unimpressive job of really understanding what’s sitting in our portfolio,” he said.

This article has been updated to correct Ruffin’s initial mortgage rate.

Current Benefits of Banking Legal Cannabis Businesses

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While historically viewed as “strange bedfellows,” more financial institutions are offering services to cannabis businesses across the country. Though their worlds may seemingly look quite different, both are highly regulated, cash-intensive industries that can solve challenges for each other.

From the cannabis operator perspective, the benefits of a strong banking partner are straightforward. This relationship offers a safe place to store the intake from cash-heavy sales, a way to make tax and other payments electronically and the ability to facilitate direct deposits for employees. Additionally, other opportunities for banks include loan opportunities and additional benefits such as partnerships with human resources/payroll, payments and insurance are becoming more common.

The benefits for financial institutions, however, are ever-evolving. Up until this year, banks primarily looked at cannabis customers as a service relationship. “I’ll take care of your business needs, and you’ll pay me service fees for doing that.” But what we at Green Check have seen over the past several months is that these relationships are starting to look far more traditional. That means financial institutions that are willing to bank, and truly work with, the cannabis businesses in their market will encounter a far bigger opportunity.

Let’s start with low cost deposits. The federal funds rate is up. Many financial institutions are staving off the certificate of deposit pricing wars by paying higher annual percentage yields (APYs), and the overall cost of funds is inching up daily. The standard play here is often to seek out commercial customers. When we look at cannabis deposits in that light, the cost of funds is most often less than 1%. That could certainly help in those asset-liability committee meetings.

Next we have fee revenue. We’ve all had that conversation around the boardroom table about replacing overdraft fee income with other options to keep noninterest income from plummeting. Opening up the traditional suite of commercial services to the cannabis industry gives a financial institution a fresh new market segment to approach, along with the additional business service fees from those new opportunities.

And what about lending? An increasing amount of our financial institution clients have begun lending to the cannabis industry. It’s often one of the first questions that cannabis operators ask when seeking out a new banking relationship, making it quickly a table stakes option. One way for banks to step lightly into lending is to begin with the smaller lending opportunities such as unsecured line of credit facilities, or even equipment financing: loans that are less than $1 million, with less complex collateralization. Other financial institutions that aren’t able to take on the larger real estate loans and build-out financing can be a participant with a lead bank who has more experience in this area.

Far from strange bedfellows, these two industries can work together synergistically. In this current high rate environment, they need each other now more than ever. However, it’s essential that any bank wanting to offer services to this complex, rapidly expanding industry seeks proper guidance. Seeking experienced help from a reliable cannabis banking firm should be your bank’s first step in reaping the benefits of working with legal cannabis.

Managing Credit Risk Without Overburdening Resources

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Increased labor costs and related challenges such as talent acquisition have affected all industries, including banks. Additionally, banks are facing potential deteriorating credit quality, growth challenges amid tightening credit standards and increased scrutiny from regulators and auditors.

Loan origination, portfolio management and credit quality reviews are key areas to successfully managing increasing credit risk. It’s critical that banks understand their risk appetite and credit risk profile prior to making any changes in these areas. You should also discuss any material changes you plan to implement with your regulatory agencies and board, to ensure these changes don’t create undue risks.

Lending
Originating new loans doesn’t have to be cumbersome and complex for both the bank and the client. The risk and rewards are a delicate balancing act. And not all loans require the same level of due diligence or documentation.

Banks might want to consider establishing minimum loan documentation requirements and underwriting parameters based on loan amounts. This can put them at a competitive advantage compared to financial institutions requiring more documentation that can increase the loan processing time.

Centralizing the loan origination process for less complex and smaller loan amounts can streamline the workflow, potentially helping with consistency and efficiency and allow less-experienced staff to process loans.

Automation may be useful if your bank has a high volume of loan origination requests. The board should consider conducting, or hiring a consultant to complete, a cost-benefit analysis that could consider automating various aspects of the underwriting process. You may find automation is not only cost effective but might reduce human errors and improve consistency in credit decisions.

Portfolio Management
Ongoing management of the loan portfolio also doesn’t have to be time consuming. Not all loans are created equal or create equal risk for the bank; ongoing management should correspond to the risk of the loan portfolio. Consider evaluating the frequency of the internal loan reviews based on various risk attributes, including risk ratings, loan amounts and other financial and non-financial factors.

Internal Credit Reviews
An annual internal credit review might be all that’s necessary for loans that have lower risk attributes, such as small-dollar loans, loans secured by readily liquid collateral and loans with strong risk ratings. Banks should instead conduct more-frequent internal reviews on larger loans, loans in higher-risk industries, highly leveraged loans, marginal performing loans and adversely risk rated loans.

When completing frequent reviews, focus on key ratios relevant to the borrower and monitor and identify financial trends. An internal review doesn’t necessarily require the same level of analysis as an annual review or effort performed at loan origination.

Payment performance or bulk risk rating could be an alternative for banks that have a high volume of small-dollar loans. These types of loans are low risk, monitored through frequent reporting that uses payment performance and require minimal oversight.

Finally, centralizing the portfolio management might be appropriate choice for a bank and can create efficiencies, consistencies in evaluation and reduce overhead expenses.

Credit Quality Reviews
From small borrowers to national corporate clients, there are many creative ways that banks can achieve loan coverage in credit quality reviews while retaining the ability to identify systemic risks.

Banks can accomplish this through a risk-based sampling methodology. Rather than selecting a single risk attribute or a random sample within the loan population, you may be able to get the same portfolio coverage and identify risks with the following selection process. Focus on selecting credits that have multiple risk attributes, such as:

  • Borrowers with large loan commitments, high line usage, unsecured or high loan-to-value, adversely risk rated and high-risk industries.
  • Select credits with a mix of newly originated and existing loans, new underwriters and relationship managers, various loan commitment sizes and property types and collateral.

Consider credits within the Pass range that may have marginal debt service coverage ratios — typically the most common multiple risk attributes for identifying risk rating discrepancies — or are highly leveraged, unsecured or lack guarantor support.

Targeted Review
More targeted reviews can offer banks additional portfolio coverage. These types of reviews require less time to complete, giving institutions the ability to also identify systemic trends. Below are some things to consider when selecting a targeted review.

  • Select a sample of loans with multiple risk attributes and confirm the risk ratings by reviewing the credit write-up for supporting evidence and analysis.
  • Complete a targeted review of issues identified in the previous risk-based sampling reviews.

Finally, for banks that have recently acquired a loan portfolio, review the two banks’ credit policies and procedures and determine where the are differences. Select loans that are outliers or don’t meet the acquirer’s loan risk appetite.

Why Blockchain Is Redefining Payments for Midsize, Community Banks

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In the weeks following Silicon Valley Bank’s downfall, the 25 largest U.S. banks experienced a $120 billion increase in deposits, according to the Federal Reserve. Meanwhile, the nation’s midsize and community banks saw deposits fall by over $108 billion during the same time period. This represented the largest weekly decline of non-megabank deposits in history and set a perilous precedent for the health of the nation’s economic engine.

Unlike megabanks, midsize and community banks are people-centric and largely focus on empowering their local communities. The collapse of Silicon Valley Bank and Signature Bank has left pressing questions for businesses everywhere: Are community and regional banks in danger of becoming obsolete? Will the future be dominated by a handful of global institutions that are unresponsive to the needs of America’s entrepreneurs and small business community?

Smaller banking’s decline is not just limited to March: Community banks’ share in total lending and assets fell by 40% between 1994 and 2015, according to a 2015 paper; the country has lost over 9,000 smaller banks since 1993. For local communities, losing a community bank often means losing access to credit for that first-time small business or aspiring entrepreneur.

In times of crisis, it is often the community and regional banks, not the megabanks, that serve the vast majority of American businesses. During the coronavirus pandemic, community banks supplied a disproportionate share of Paycheck Protection Program loans, despite having budgets that pale in comparison to those held by the largest financial institutions. Additionally, they provide pivotal working capital to American businesses: community banks are responsible for 60% of all small-business loans and more than 80% of farm loans.

While America’s largest banks continue to dominate the market, the country’s smaller banking institutions are left with few options to compete with gargantuan research and development  budgets at megabanks.

While community banks are spending more to build out technological capabilities — as evidenced by cybersecurity and contactless digital payments growing by a median increase of 11% in 2021 — there is still a key technology that can transform their commercial banking capabilities and provide them with a competitive advantage versus the megabanks: private permissioned blockchain.

Private permissioned blockchain solutions operate in sharp contrast to traditional payments platforms, which are limited by high transfer fees, transaction size limits, 9-to-5 hours of operation and lengthy time delays. Payments made using private blockchain, on the other hand, enable community banks to offer their corporate clients secure, instantaneous transactions around the clock and at a fraction of the cost. This technology also enables banks to provide customized payments and financial services for every industry and for businesses of all sizes.

Fraud and regulatory efficiency are also key factors for banks to consider. Fraud losses cost banks billions of dollars every year, with a multiple of that figure spent preventing, investigating and remediating fraud. These costs are growing rapidly, and community banks lack the resources of the megabanks to address this growing issue.

In contrast, private permissioned blockchains are only accessible to authorized users, resulting in a dramatic reduction in fraud incidence, which correspondingly reduces the costs to prevent and respond to fraud cases. Critically important for smaller banks, private blockchain are also not expensive to implement and can be installed swiftly and efficiently on existing legacy core banking platforms.

Offering corporate clients a secure, efficient and customized payments and financial solutions 24 hours a day using private permissioned blockchain gives community banks the ability to capitalize on their key competitive advantage: close proximity to small businesses.

Business-to-business, or B2B, payments continue to hold a wealth of promise for community banks. Experts estimate that over 40% of all B2B payments are still conducted through paper checks, creating glaring inefficiencies and security issues plaguing community banks already struggling to compete.

One solution to close the gap between large banks and community banks is implementing emerging technologies that level the playing field without investing enormous amounts of capital to overhaul their entire tech stacks.

We are at a crossroads in U.S. financial history; the future of the country’s midsize and community banks hangs in the balance. Technology has proven to be the great equalizer, especially during periods of economic distress and financial uncertainty. Private permissioned blockchain adoption offers a lifeline that community banks desperately need in order to survive and prosper.

Reduce Lending Risk in the Omnichannel Environment

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Credit risk and risk associated with digital origination and authentication have become top of mind for bank boards and executives. Banks that are able to optimize lending practices to give consumers faster and more efficient experiences and interactions throughout their digital lending journey are seeing greater pickup and success.

Today, many borrowers prefer application processes that accommodate both digital and staff-assisted capabilities when seeking a loan. To process loans in an omnichannel delivery ecosystem, banks are turning to lending options that have the ability to prospect, originate, underwrite, process and close secured and unsecured credit cards, lines of credit and installment loans.

Manually assessing an applicant, their collateral and whether the loan meets the bank’s compliance requirements and lending policies increases the risk of inconsistencies, oversights and unintended consequences. Automation provides institutions with consistent inputs, analysis, compliant processes and calculations, predetermined classifications, accurate risk-based pricing, consistent warnings for policy exceptions and predictable decisions and outcomes with greater speed and efficiency. It also improves the interpretation and analysis of the applicant, credit, debt obligations, collateral and the execution of the institution’s inclusion/exclusion policies, such as summing up debt totals and calculating ratios used in the underwriting process. It can calculate the proposed loan payment, annual percentage rate (APR), and ratios at the applicant, household, business, guarantor and loan levels. It can also calculate custom credit scores.

While banks receive many benefits from using digital channels to serve borrowers, they also face vulnerabilities and risks such as fraudulent applications and data privacy concerns. In addition, digital lending might require a bank to collaborate with numerous third-party fintechs, exposing both borrowers and the institution to new and heightened levels of risk.

Banks need more cost-effective processes and decision models to address qualification ratios associated with online lending. These models should employ analytics and automation that can decline, decision, and refer applications appropriately to maintain an institution’s profitability, mitigate risk and not overwhelm lenders.

Mitigating Credit Risk and Increasing Productivity
Technology simplifies the loan origination process for banks and customers by guiding customers through each step in the process. Technology and automation can eliminate errors and the need to rekey data, which streamlines operations and enables staff to focus on additional revenue-generating opportunities.

Institutions that would prefer to slowly test automated decisioning can start with automated decisioning for denials for applications that fall outside of loan policy. An instant denial allows loan teams to focus on profitable and better-qualified candidates. Decisioning analytics evaluate areas such as credit quality, borrower stability and collateral risk. A decision and rules engine applies industry standards, institution-specific rules and policies and custom attributes, such as credit report analysis, for automated decision support during the loan origination process.

Automated solutions can provide speedy decisions while meeting compliance standards. This can help boost employee productivity; the consolidated customer information and loan details provides a 360-degree view of the overall financial relationship and deal structure. Bank associates can manage and expand relationships and target product recommendations based on customer needs.

An Omnichannel Environment for Lending
The technology and analytics of an omnichannel environment gives banks a competitive advantage when it comes to loan origination. Applicants can shop and compare loan options, submit loan applications and receive real-time automated decisioning and status updates.

An omnichannel ecosystem provides seamless start, save and resume cross-channel application processing: customers can begin the research and application process on a mobile device, continue the application and upload documents on an alternate digital device, and engage live assistance from contact center or branch lending specialists without losing their progress. The technology can guide customers and staff members through each phase, improving customer engagement by triggering staff actions and automating workflows. Digital capabilities intertwined with human engagement increases staff productivity and efficiency through analytics and workflow.

The omnichannel approach balances technology and human resource allocation based on customer need and complexity. Technology automates business criteria to issue decisions in real time or have the loans manually reviewed by underwriters, if warranted. Applying decisioning analytics allows banks to strengthen governance, risk and compliance by establishing proof of process. An omnichannel delivery environment that drives the application and origination process gives banks a way to provide a seamless lending experience that meets customers’ needs.

Commercial Real Estate Threatens to Crack Current Calm

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While credit quality at banks remains high, it may not stay there. 

At the end of the year, noncurrent and net charge-off rates at the nation’s banks had “increased modestly,” but they and other credit quality metrics remained below their pre-pandemic levels, according to the Federal Deposit Insurance Corp. However, rising interest rates have made credit more expensive for borrowers with floating rate loans or loans that have a rate reset built into the duration. 

Commercial real estate, or CRE, is of particular focus for banks, given changes to some types of CRE markets since the start of the pandemic, namely office and retail real estate markets. Rising interest rates have increased the monthly debt service costs for some CRE borrowers. An estimated $270.4 billion in commercial mortgages held at banks will mature in 2023, according to a March report from Trepp, a data and analytics firm. 

“If you’ve been able to increase your rents and your cash flow, then you should be able to offset the impact of higher financing costs,” says Jon Winick, CEO of Clark Street Capital, a firm that helps lenders sell loans. “But when the cash flow stays the same or gets worse and there’s a dramatically higher payment, you can run into problems.”

Some buildings are producing less income, in the form of leases or rent, and their values have declined. Office and traditional retail valuations may have fallen up to 40% from their purchase price, creating loan-to-value ratios that exceed 100%, Chris Nichols, director of capital markets for SouthState Bank, pointed out in a recent article. SouthState Bank is a unit of Winter Haven, Florida-based SouthState Corp., which has $44 billion in assets. If rates stay at their mid-April levels, some office building borrowers whose rates renew in the next two years could see interest rates grow 350 to 450 basis points from their initial level, Nichols writes, citing Morgan Stanley data.  

JPMorgan & Co.’s Chairman and CEO Jamie Dimon said during the bank’s first quarter 2023 earnings call that he is advising clients to fix exposure to floating rates or address refinance risk.

“People need to be prepared for the potential of higher rates for longer,” he said.

Banks are the largest category of CRE lenders and made 38.6% of all CRE loans, according to Moody’s Analytics. Within that, 9.6% of those loans are made by community banks with $1 billion to $10 billion in assets. CRE exposure is highest among banks of that size, making up over 24% of total assets at the 829 banks that have between $1 billion and $10 billion in assets. It’s high for smaller banks too, constituting about 18.3% of total assets for banks with $100 million to $1 billion in assets. 

“Not surprisingly, we’re seeing delinquency rates for office loans starting to increase. … [It’s] still moderately low, but you can see the trend has been rising,” says Matthew Anderson, managing director of applied data and research at Trepp, speaking both about year-end bank data and more current info about the commercial mortgage-backed securities market. He’s also seen banks begin increasing their credit risk ratings for CRE segments, notably in the office sector.

Bank boards and management teams will want to avoid credit surprises and be prepared to act to address losses. Anderson recommends directors at banks with meaningful CRE exposure start getting a handle on the portfolio, the borrowers and the different markets where the bank has exposure. They should also make sure their risk ratings on CRE credits are up-to-date so the bank can identify potential problem credits and workout strategies ahead of borrower defaults. 

They will also want to consider their institution’s capacity for working out troubled credits and explore what kind of pricing they could get for loans on the secondary market. While banks may have more capital to absorb losses, Winick says they may not have the staffing to manage a large and rapid increase in troubled credits. 

Working ahead of potential increases in credit losses is especially important for banks with a concentration in the space, which the FDIC defines as CRE that makes up more than 300% of a bank’s total capital or construction loans in excess of 100% of total capital.

“If a bank has a CRE concentration, they’re definitely going to get more scrutiny from the regulators,” Anderson says. “Any regulator worth their salt is going to be asking pointed questions about office exposure, and then beyond that, interest rate exposure and refinancing risk for all forms of real estate.”

Risk issues like these will be covered during Bank Director’s Bank Audit & Risk Conference in Chicago June 12-14, 2023.

The Big Opportunity in Small Business Lending

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In the years following the financial crisis of 2007-08, bank lending to small businesses slowed considerably, due in large part to the economic fallout and new financial regulations. At the same time, nonbank lenders began to rapidly fill the small business lending void left by banks struggling with their own risk appetites and new regulations.

According to recent research, 32% of small businesses applying for loans today do so through nonbank lenders, up from 24% reported in 2017. This data seems to suggest a significant and accelerating shift in how small businesses seek access to capital. It also highlights a significant opportunity for today’s community banks to retake small business lending market share.

Bankers are risk managers by nature, which often leads them to shy away from small business lending that is sometimes seen as riskier, especially in times of economic stress. Community banks may also lack the proper technology to efficiently process these transactions and achieve the necessary return on investment. Banks are cash flow lenders; for the most part, they prefer to spread financial statements similarly to as they do with their larger, more profitable CRE loans. This entails extracting and organizing data from borrowers’ financial statements and tax documents into a bank’s overall financial analysis system, which enables the institution to make better, more accurate credit decisions and identify risks.

However, spreading financials on small dollar business loans drastically reduces or eliminates profits. Moreover, most banks lack adequate credit data for their small business customers. Many banks hesitate to lend based solely on information from FICO or FICO Small Business Scoring Service , as they sometimes do not accurately assess business risk or repayment ability.

In response, small businesses have increasingly turned to nonbank lenders that provide a frictionless experience with end-to-end technology. Additionally, this robust technology also tends to provide a better customer experience and a much faster loan approval process.

Some nonbank lenders have also leveraged new or alternative data and scored loan models. This allows them to serve many previously marginalized or ignored business owners. Luckily, today’s community banks can leverage similar models and help expand financial access for many underserved borrowers in their local communities, reaching untapped markets while still properly managing risk.

With over 33 million small businesses in the United States, there is a tremendous opportunity for community banks to take back market share and capitalize on their relationship business model. Bankers should evaluate modern lending platforms that support an end-to-end process to optimize efficiencies and provide a positive customer experience — and do so cost effectively. Additionally, data and scoring models that are designed to support small dollar lending provide community banks with an opportunity to quickly expand their small business lending portfolio while meeting customer needs and mitigating risk.

Community banks are perfectly positioned to leverage their relationship business model and grow small business lending. Small business owners should have the choice of working directly with their local bank. Small business lending provides community bankers with a new revenue opportunity, a diversified loan portfolio and access to additional deposits. As nonbanks continue to disrupt small business lending, it is essential for bankers to modernize their small business lending technology and strategies to capitalize on this untapped market.