There are a million reasons for leveraging fintech to enhance a financial institution’s small business lending experience. To name a few, there’s better efficiency, customer convenience, profitability, speed to decision, speed to capital, cost reductions and a much-improved overall customer experience. However, one that often gets lost in the fray is the impact technology will have on the day- to-day productivity, motivation and morale of the bankers who work so hard to source and sell small business loans. This “banker experience” as it is known, plays a huge role in sales performance, retention, revenue generation and employee satisfaction.
The reality of a day in the life of a small business lender is that a surprisingly small amount of time is spent on sourcing new opportunities or even cross-solving to sell deeper into an existing relationship. Because they are shackled with the responsibility of shepherding deals through the multiple steps in the lending process, the more loan deals a banker has, the less time he or she is able to spend growing the book of business. So how are they spending their time?
As many as 80 percent of applications come in either incomplete or with an error on them, delaying the decisioning process and requiring the banker to go back to the client again and again.
Unique borrowing situations prompt the back office to request additional information requiring the banker to reach out and coordinate the collection of the information.
The collection of documents in the “docs and due diligence” phase of the approval process is tedious and time consuming. Bankers spend a great deal of time reaching out to applicants asking for things like: entity docs, insurance certificates, tax returns and so on.
Multiple teams and individuals touch each deal and as a result, things get lost, forcing the banker to invest a great deal of time and energy babysitting deals and checking on their progress from application to closing.
Much of the processing time is dependent upon the borrower’s promptness in getting requested information back to the bank. Bankers spend countless hours making multiple calls to collect information from clients.
I ran small business sales for a $150 billion asset institution, and our data proved that whenever a banker had as little as two loan deals in the workflow process, their new business acquisition productivity was reduced by 50 percent. Bankers with five deals in the process had their acquisition productivity diminished by 75 to 80 percent. That’s because they expend all their time and energy shepherding deals through the various stages of the process, gathering additional documentation, or monitoring the progress of each deal.
All of this is challenging for one person to do… but simple for technology to handle automatically, accurately and consistently. Technology can ensure an application is complete before it is submitted. It can ping the client for any-and-all documentation or data required. It can communicate progress and monitor a deal at every step in the lending process. Technology can also facilitate the collection of more and better data and translate that data into information that enables the banker to add value by asking great questions that help solve more problems for the customer.
When technology is used end-to-end, from application to closing, bankers are able to focus on the important things like:
Sourcing new opportunities.
Cross-solving for existing customers.
Preparing for sales calls and follow-up activities to advance the sales process.
Providing clients and prospects the value that earns trust and feeds future revenue.
Growing their loan book, and their portfolio revenue.
Technology makes the banker’s life simpler. When bankers are able to do what they do best, which is sell, job satisfaction, performance, job retention and morale go through the roof. And that positivity translates into improvements in the customer experience, and increases in revenues for the institution.
Considered by some bank accounting’s most significant change in 40 years, the FASB’s Current Expected Credit Loss (CECL) standard is inching toward reality.
Are you and your board colleagues studying the standard’s fundamentally new requirements for booking loan losses? Do you have a sense for its implications on reserves? Are you considering the penetrating questions to ask about management’s preparedness and processes to comply?
For some directors, the standard might seem straightforward: Build reserves to cover losses over the life of a loan. But it means much more: The timing of adding to the reserve has changed considerably. The entire expected lifetime losses must be booked in the quarter in which the loan is made.
Make no mistake; preparing to meet the demands of the standard, effective January 1, 2020, for most Securities and Exchange Commission (SEC) registrants, promises be a complex, time-consuming endeavor.
Other questions bank directors must ask themselves include whether they understand the standard’s implications and if they are confident that bank management is prepared for the formidable changes affecting modeling, data collection and analysis, calculation of losses, and information technology (IT) systems.
For some bank management teams, the answer may be a confident, “Yes.’’ For others, it might be a tentative, “Well … let us get back to you on that.’’
It is worth noting that 83 percent of bankers who answered a recent survey at the American Institute of Certified Public Accountants conference said they expected CECL to require substantial changes to banks’ policies, procedures and IT systems. Half said they were most concerned about how they would manage the amount of data needed to comply.
Consider this counterintuitive CECL scenario: the bank has a quarter it considers successful because of the number of new organically grown loans it made. But, it might show a quarterly loss because the bank must book expected losses for the entire life of those loans in the quarter in which the loans were made. Under current rules, banks book losses after they are incurred.
Further, when calculating expected losses under CECL, banks must incorporate reasonable and supportable forecasts in their loss evaluations. In other words, how strong are your bank’s modeling capabilities?
That forecast would include a bank’s expectation, for example, of the future yield curve and an expectation of the economic future over the life of the loan–and how these factors would impact the performance of each loan for the life of the loan.
For some banks, the timing issue could mean between now and 2020, they will need to add to their capital base through earnings. Capital planning considerations are most effectively dealt with when given sufficient lead time, especially if a number of institutions need to raise capital upon adoption of the standard.
Directors must prepare to challenge management’s process to meet the standard. That may mean that directors ask management if they’ve examined commercial loans by type or vintage, and if they’ve done preliminary lifetime loss calculations based on past experience and future economic considerations.
Consequently, directors need comfort that management has established a robust CECL planning process in order to know which data will be required. It’s no wonder, then, that for many directors, that standard looming on the horizon suddenly is getting closer.
To set the stage for a successful technology implementation, it takes more than just training your staff or setting up a platform. You also need to understand your firm’s strategy, culture and people—and know how the new technology will enhance all three.
Increased competition, shifting customer expectations and more diligent enforcement of expanding regulation are making the commercial lending space a tougher place to do business.
It’s true that commercial loan growth is expected to hit 11 percent in 2016. That impressive growth belies a challenging market environment. In truth, lower interest rates and higher costs of doing business are squeezing lenders’ margins. To paraphrase an old joke: Financial institutions need to avoid losing money on every loan, while “making it up in volume.”
Financial institutions that want to avoid becoming a punchline are responding strategically, investing in core technologies and leveraging the new analytical capabilities of solutions to drive product-level profitability.
Due to the increased cost of doing business and the need to operate in a leaner environment, most financial institutions do not possess the internal expertise needed to properly plan and execute enterprise-wide process change. This lack of experience leads to longer success rate times and reduced buy-in by end users and management.
According to the technology and consulting firm CEB, a vast portion of business-led technology adoption happens without the input of information technology, with nearly half of originators saying they are willing to forgo quality for speed. This lack of planning is showing up in the final output. Eighty-five percent of the “stall points” in the adoption of new technology result from a lack of planning, with just 15 percent related to issues around the implementation itself.
So, what are the steps that your financial institution needs to take to ensure the success of your implementation?
Identify What Change is Needed: The institution needs to have a clear idea of what needs to change, and the metrics by which the success of the change will be measured. To make this happen, it’s important to have an executive steering committee, to get senior-level buy-in around a common goal.
Organize the Core Team: Next, it’s important for the institution to assemble a wide variety of cross-functional teams to allow free-thought around how paradigms at the firm could change. Effective tech implementations mean new processes, not just swapping one platform for another. To ensure that those paradigms work across the organization, everyone who will interact with the new system needs representation. For a commercial implementation, this means including representatives from the front line, such as relationship managers, all the way to the back-office, such as loan processors.
Choose a Champion: Financial institutions have to make a careful choice of the person who will be the face of change. The final candidate should be a strong communicator who can explain the benefits of the change to everyone in the organization.
Thoroughly Scope Business Requirements: Conduct a full scoping and planning session with your technology provider to understand business rules, as well as the existing systems and processes that need to change as a result of implementation.
Identify Key Implementation Resources: The financial institution needs to allocate the correct resources to maximize productivity and efficiency throughout the implementation. The creation of an implementation steering committee (separate from the executive steering committee we discussed above) can also help minimize design changes that need to occur after the implementation begins. This steering committee should also ensure that the changes have no unintended consequences for the organization.
Create Program/Project Plans: Will the project be an enterprise-wide implementation or focused on a specific area? Is the organization better suited to a waterfall or agile implementation methodology? (A waterfall implementation tends to be linear and sequential, while an agile approach is incremental and iterative, with processes occurring in parallel.) Will the rollout of the new technology be a “big bang” or phased? These issue need to be addressed in advance, along with the standard project timeline.
Most importantly, financial institutions need to work deliberately and efficiently, and avoid hurrying the process. Rushing into a mistake will delay the outcome longer than working slowly and effectively. As they say in the Navy SEALS: “Slow is smooth, and smooth is fast.”
Careful planning can significantly reduce the amount of time that a financial institution requires for the implementation, and speed up the time to realize the benefits. The key is planning right—from the beginning.
Pennsylvania, Ohio, and New York might not offer the same growth opportunities as some other parts of the country, but that didn’t prevent Bank Services member S&T Bancorp from reporting record earnings in the third quarter of this year. Well managed institutions usually find a way to perform even when the conditions are less than optimal, or they’re located in slower growing markets. With $6.7 billion in assets, S&T is headquartered in Indiana, Pennsylvania, a small college town located about 50 miles northwest of Pittsburgh. It is an area that depends on manufacturing, service companies and Indiana University of Pennsylvania—the community’s largest employer—for jobs. Natural gas exploration in the Marcellus Shale formation, which runs through the region, also has been an ascending industry.
In recent years, S&T has expanded its lending activities into Ohio and Western New York, while also expanding its branch network west to the outer rim of Pittsburgh and east to Lancaster, Pennsylvania. Todd D. Brice, who has served as president and chief executive officer since 2008, talked recently with Bank Director Editor in Chief Jack Milligan about a range of issues, including loan growth in S&T’s three-state region.
What’s happening in the loan market in your three-state area? Brice: I think it’s pretty steady. We’ve made some pretty significant investments over the last four years or so to diversify the company. Our roots are in Western Pennsylvania, but in 2012, we opened up a loan production office in Akron, Ohio, and in ’14 we jumped down to Columbus, Ohio, with another team of bankers. Last year we acquired Integrity Bank in the Harrisburg/Lancaster market, which was about an $800 million institution. That got us into the Central Pennsylvania market. We also opened up a loan production office in Rochester, New York.
What we’re finding out is that each market provides different opportunities, and it gives us the ability to shift. If you’re seeing a softness in one market, you can focus attention in another market. I think one of the hallmarks of our company has been our ability to grow organically over our history, and then augment that with select M&A.
Were these lending teams recruited away from other organizations? Brice: Yes. In Akron, we originally had three people; today we have eight people in that office. In Columbus we started out with four people and we have eight. Western New York is a market that we’ve been lending into probably for 15 years. Our philosophy is not so much just to get into a market, but get into it with the right people. We were finally able to land a gentleman to lead the team up there, and then he was able to go out and recruit other high caliber bankers to the organization. All the bankers that we brought on board have very extensive experience in their respective markets.
In markets like Columbus and Akron, would it be logical to follow up those loan production offices with acquisitions at some point, if you found something that made sense? Brice: We just haven’t found the right fit for us. I think if you look at our history, we’ve been pretty disciplined, and try and stick to a model that has seemed to work for us, but we’ll continue to keep our eyes open.
In Akron, we haven’t been able to find the right partner so we decided to open a full-service branch that will use a private banking-type model.
Are you worried about a recession? Brice: I think you’re always worried about a slowdown. That’s why we’ve made significant investments over the last six years on the risk management side of the business. We monitor the loan portfolio in a number of different ways to try and keep an eye on concentrations, by product type or by markets, so if there is a downturn we can weather it a little better than some of the other folks.
The consumer financial services market is increasingly becoming mobile in its focus. Does that present challenges for S&T, or do you feel like that doesn’t really impact you because you’re [more of a commercial] bank? Brice: Mobile is an important distribution channel for us. I won’t say we’re going to be the first to market with a new technology, but we have a good partner in FIS and they get us up to speed pretty quickly, so we feel we have a pretty competitive suite of products. We just did an analysis on how we rank in different categories, whether it be online, mobile, bill pay, online account openings on deposit side and loan side, online financial management tools, text alerts, mobile deposit, remote deposit capture. We think that we compare favorably with our competitors, but it’s something we definitely need to keep an eye on going forward because while commercial banking gets a lot of the spotlight, consumer has been a very strong line of business for us for many years. We’re a 114-year-old company and we’ve built up a nice little franchise over that period of time.
Is the demand for mobile-based products, or mobile-based services, as strong in a smaller market like Indiana, Pennsylvania, as it would be in a larger urban area? Brice: Some of the things you’re seeing in the metropolitan markets, like branches that rely more on technology than people, I would say some of the rural markets we’re in are probably not quite ready for that. We are looking at taking that approach in some of our urban markets. Everybody has a mobile phone and they want to stay connected, so it’s important for us to make sure that we have those products to offer them. Fifty percent of our customer base use our online baking product, and another 15 percent also use our mobile banking product, which compares favorable to the utilization rates of our competitors.
The bank reported record third quarter earnings in October. What were the two or three things that helped drive that performance? Brice: We had a lot of things go our way. We were up 20 percent over the second quarter and another 9 percent over the third quarter of last year. Our average loan book was up about $100 million for the quarter. That helped to grow [net] interest income by about $1.7 million. Another area that we focus on pretty extensively is expense management. We were down approximately $400,000 quarter over quarter. We had a recovery on a prior loan that helped us out, but also our data processing costs are down about $600,000 a quarter. We renegotiated a contract which was effective July 1.
Then we had a nice little lift on fee income which was up about a $1 million quarter over quarter. Some of that was driven by mortgage activity and also increased debit card income. Credit costs were down about $2.3 million quarter over quarter. We had a little bit of a spike in the first quarter in credit losses, but we’re seeing that kind of come back into line.
How does the fourth quarter look? Brice: I like how we’re positioned. I think we’ve demonstrated that we have a good team of bankers that is able to go out and grow the business organically. I like the markets that we’re in; they are going to provide varying degrees of opportunity. I think long-term, we’ll keep our eyes open. We don’t feel we have to go out and do anything immediately on the M&A side. If the right opportunity pops up, we’ll certainly take a look, but we’re going to be disciplined on how we evaluate it.
What do you expect from your board? How can the board be helpful to you? Brice: When you look at the makeup of the board, we have three former bank CEOs. All of them have extensive knowledge of the industry, so they are great mentors, great sounding boards, and they give me a different perspective on how I would evaluate things from time to time. Our other board members who are not former bankers bring different skill sets, whether it’s specific industry knowledge or an understanding of the markets we operate in. I think we have a very effective board. They challenge management, but at the same time, they support us to make sure our management team is doing a good job for our shareholders.
Last question: What is your dream vacation? Brice: I like to spend some time in the Del Mar, California, area. You get down by the beach in August and it’s 75 degrees in the afternoon and 65 at night. It’s just a nice little quiet getaway. My wife and I and the kids like to get out there from time to time.
You’ll have to do an acquisition in Southern California so you have a reason to go there. Brice: (laughs) If I did that, then I’d have to go out there and work! That’s why I like to get out there and get away.
The story in the iconic movie, “It’s a Wonderful Life,” is one that a lot of bankers can relate to.
The obvious connection: The protagonist, George Bailey, is a banker. But bankers can also see themselves in the tough choices George faces throughout the movie. Over and over again George must decide between taking the easy way out or doing something that’s more difficult, but which he knows in his heart is right. The banking industry currently finds itself in a similar tricky situation.
After years of new regulations and low interest rates, growth and earnings are hard to come by. To cope, banks have looked inward, focusing on cost-cutting and regulatory compliance, often at the expense of their customers. This frequently manifests itself in the most important discussion there is between a bank and their commercial customers: the negotiation of loan pricing.
Focusing on better pricing means shifting priorities at banks and doing some very difficult work in the immediate future. It’s a hard path to follow, but it’s the right choice; the one George Bailey would make. Banks that elect to take this route must learn to avoid three common mistakes when it comes to pricing loans.
1: Focusing on the Math, But Not the Execution Truly successful pricing has two dimensions: Price setting and price getting.
Price setting is the math of determining what price is appropriate given the structure and risk profile of any particular deal. Most banks do fairly well with this dimension.
Price setting covers everything from the communication of the math from the back of the bank to the front, to the negotiation between borrower and lender. Many banks continue to struggle with this dimension. To make matters worse, when their pricing isn’t working, they always turn to the math to find a solution. The bottom line is that you can’t “out-math” the competition. You have to be better at the price getting aspect, which is all about how you interact with and serve your customers.
2: Opting for “Let Me Check With My Boss” To that end, the first issue banks should focus on is moving the pricing decision closer to the customer. In most loan negotiations, the lender knows the starting point (i.e. the desired outcome) of the deal. However, once the customer pushes back on the pricing, the lender does not know how to reach the target profitability without losing the deal, and has to resort to the classic car salesman line of “Let me check with my boss to see if we can do that.”
Generally, the lender and borrower will discuss a price and structure, and then an analyst will input the deal into a pricing model. The deal is being measured on a pass or fail basis. If the deal fails, the bank must either go back and re-trade everything with the customer, or, more likely, just decide to take less on this deal, and “try to do better next time.” The only fix for this issue is to move the decision closer to the customer. The lender should be measuring against targets, and have the ability to negotiate on the fly while the customer is sitting in front of them.
3: Making It “All About the Rate” Part of that negotiation will, of course, be about interest rate. It is the most visible and contested part of the deal. It is also the “sticker price” from your competitors when borrowers start shopping.
However, the great thing about commercial loans is that all aspects are negotiable, and they all move the needle in terms of risk and profit. Why not make that 60-month balloon a 55-month balloon to remove interest rate risk? Why not add collateral to reduce expected loss and provisions? If the lender can easily see what all of those terms are worth, they can trade any of them for rate.
In today’s world, customer expectations have changed. They are used to being able to get what they want, when they want it. They expect the same from their bank, and this is the best way to provide that. Give your lenders the ability to custom build financing for their customers in a responsive way, and you will earn the higher returns that you seek.
Just like in the movie, “It’s a Wonderful Life,” your tough choice will lead to a happy ending for everyone involved.
A Georgia bank CEO was recently quoted as saying that he doesn’t “need technology that is going to help make more loans,” but technology that will “help make the loans [he’s] already making more efficiently.” His comments represent a much larger discussion about the the role of financial technology to either disrupt the banking industry or enable banks to respond more quickly to changing consumer expectations for things like speed and convenience. While non-bank financial startups are centered around technology and exploring how it might revolutionize banking, banks are trying to understand how technology can impact their existing operations and customer experience.
Specific to commercial and small business lending, there are five key areas where banks can incorporate technology to position themselves for improved performance, service and longevity given today’s market conditions and competitive factors:
Measuring financial efficiency
There are two ways to measure efficiency; the first is the financial definition of efficiency, or the efficiency ratio. The second is the practical type, characterized by shortened turnaround times, faster processes and easier methods. Both types of efficiency can be influenced by technology, but the current lending landscape calls for more focus on the latter. Using technology to speed up processes and eliminate waste will ultimately create higher and more consistent profits, a more resilient risk profile and employees empowered to make better decisions.
Achieving efficiency through auto decisioning
In an era where the rise of alternative lenders has prompted customers to demand instant action on loan queries, banks must be able to quickly and accurately deliver loan verdicts. By implementing auto decisioning technology, banks can more effectively compete against digital-platform lenders, and then grow that business. Banks’ advantage over non-bank lenders lies in their funding stability and mindfulness of operational compliance. Getting up to speed—literally–in delivering quick, smart loan approvals can give them a big boost.
Embracing the digital relationship with business customers
Banks have an opportunity to leverage technology solutions to not only better connect with their current customers, but also to attract new ones by supplementing face-to-face interaction with digital tools. Arm bankers with tools in the field so that they may meet customers where they are, and perform the same functions they could in-branch. And provide customers with a digital channel so they can track the status of a loan or complete and return important documentation from their home.
Engaging in treasury management opportunities
Treasury management is a valuable business for banks, and an area that many experts predict will have an expanding role in coming years. However, the onboarding process can be a very complex one encumbered by manual processing and poor workflow management. Transitioning to electronic documents for onboarding and seeking to automate pricing, approval and even status tracking will offer significant rewards to banks’ commercial transaction goals.
Acquiring and retaining the right talent
In recent years, the industry has experienced an alarming trend in young talent either not being interested in banking or unexpectedly leaving the industry. A large factor in this decision is banks’ hesitation to replace dated legacy systems in favor of new, cutting-edge technologies. Employees want to work in an environment where the systems they use mirror the technology user experience they have in their personal lives — intuitive, streamlined and empowered.
I predict 2016 will be the year when bankers more completely embrace technology and view it as a tool that will take their institutions into the next generation by allowing them to do the same things they’ve always done, but with much greater speed and efficiency.
For most banks, organic growth comes from loans. Commercial real estate (CRE) lending is the top source for loan growth, according to the executives and board members responding to Bank Director’s 2015 Growth Strategy Survey. With financial institutions continuously looking for organic growth opportunities, Bank Director asked our program members: “How has your bank’s commercial real estate lending strategy changed or evolved for your institution in recent years?”
Here is a selection of their responses.
“Our CRE strategy remains in place in that we seek opportunities that fit within our risk appetite. We have evolved in that we are adding talent to the organization for commercial & industrial (C&I) banking as well as specialty finance. This broadens our profile and puts less dependency on CRE as the only source of commercial revenue.”
“We are going longer for term loans, focusing more on owner-occupied real estate, and doing employee lift-outs to take advantage of loan officers’ contacts.”
“Our strategies related to commercial real estate lending have evolved over the last five years. We are much more focused today on maintaining more diversity in the portfolio, and paying close attention to concentration levels in the portfolio relating to geography and purpose. We have lowered our ‘hold’ levels significantly, and tend to participate out larger levels of credit exposure to partner banks. We underwrite to stricter standards, including debt service coverage, and very rarely, if ever, approve any policy exceptions.”
“We have not really changed any of our philosophies regarding commercial real estate over the last several years. We do insist on seeing leases for new construction of strip centers that will show a minimum of 75 percent occupancy to start. Owner-occupied [real estate] requires a lower loan-to-value [ratio].”
“One thing we have not done in order to grow our CRE portfolio is compromise our underwriting standards. Two strategic things we changed is [to] raise our self-imposed lending limit, and how we aggregate relationships with similar ownership. Both of these changes provide us with a greater ability to meet the borrowing needs of commercial customers, reduce our outbound participation activity and provide growth in the portfolio.”
“The bank whose board I sit on hasn’t changed much, other than adding a new business line, quick-service franchise restaurant financing. Our focus is still on relationships, which generate core deposits.”
We hope this spirit of sharing provides insight and value to your bank’s board. If you have a question you need answered, please send your inquiries to firstname.lastname@example.org. We also encourage you to comment below if you would like to share how your bank’s CRE lending strategy has evolved.
Traditional banks, which are typically run by baby boomers and older Gen X’ers, are still trying to figure out the next big generation of consumers.
Sixty percent of bank CEOs and directors responding to Bank Director’s 2015 Growth Strategy Survey, which was sponsored by the Vernon Hills, Illinois-based technology firm CDW, indicate that their bank may not be ready to serve millennials, which this year surpassed baby boomers as the largest segment of the population, according to the U.S. Census Bureau. As digital use increases among an increasingly younger customer base, truly understanding and planning for the digital needs and wants of consumers seems to continue to elude bank boards: Seventy percent of bank directors admit that they don’t even use their own bank’s mobile channel.
Bank Director contacted chief executive officers, chairmen, independent directors and senior executives of U.S. banks with more than $250 million in assets, to examine industry trends regarding growth, profitability and technology. Responses were collected online and through the mail in May, June and July, from 168 bankers and board members.
Instead of millennials, banks have been finding most of their growth in loans to businesses and commercial real estate, which is their primary focus today. Loan volume was the primary driver of profitability over the past 12 months for the institutions of 88 percent of respondents, and the majority, at 82 percent, expect organic loan originations to drive future growth at their institutions over the next year. Eighty-five percent see opportunities for growth in commercial real estate lending, and 56 percent in commercial & industrial (C&I) lending. Total loans and leases for the nation’s banks grew 5.4 percent year over year, to $8.4 trillion in the first quarter 2015, according to the Federal Deposit Insurance Corp.
Despite the rise of nonbank competitors like Lending Club and Prosper in the consumer lending space, just 35 percent of respondents express concern that these startup companies will syphon loans from traditional banks. Just 6 percent see an opportunity to partner with these firms, and even fewer, 1 percent, currently partner with P2P lenders to expand their bank’s portfolio. Few respondents—13 percent—see consumer lending as a leading avenue for loan growth.
Other key findings:
Forty percent of respondents worry about potential competition from Apple. Just 18 percent indicate their bank offers Apple Pay, with 63 percent adding that they “don’t think our bank is ready” to offer the feature to their customers.
More boards are putting technology on their agendas. Forty-five percent indicate their board discusses technology at every board meeting, up 50 percent since last year’s survey. Almost half of respondents say their board has at least one member with a technology background or expertise.
More than three-quarters indicate plans to invest more in technology within their bank’s branch network.
More than 80 percent of respondents indicate that their bank’s mobile offering includes bill pay, remote deposit capture and account history. Less common are features such as peer-to-peer payments, 28 percent, or merchant discounts and deals, 9 percent, which are increasingly offered by nonbank competitors.
For 76 percent of respondents, regulatory compliance causes the greatest concern relative to the growth and profitability of their institutions, and 64 percent say the high cost of regulatory compliance had a negative impact on their bank’s profitability over the past 12 months. Low interest rates, for 70 percent, were also a key impediment to profitability.
Small Business Administration (SBA) lending is one of the key lending activities that can quickly and dramatically improve the bottom line of a community bank. It is not that difficult for a bank to generate $20 million in SBA loans, which will earn the institution between $1.0 to $1.2 million in pretax net income, if the loan guarantees are sold. Some bankers get concerned because they have heard stories of the SBA denying loan guarantees and that the SBA loan process is too time consuming and complex.
Sourcing SBA Loans The basic strategies that most successful SBA lenders use to source SBA loans are as follows:
Hire an experienced SBA Business Development Officer (BDO), who can find loans that fit your credit parameters and geography.
Source loans from brokers or businesses that specialize in finding SBA loans.
Utilize a call center to target SBA borrowers.
Train your existing staff to identify and market to SBA loan prospects.
I have put these in the order of which approach is likely to be the most successful. However, ultimately it is the speed of execution that enables one lender to beat out another in the SBA business. So if you want to hire that high producing SBA BDO, the bank needs to have a clear idea of the types of credits that they will approve and a process that can quickly get them approved.
This can create a catch 22 for the lender, since in order to justify hiring SBA underwriters and processing personnel, you have to make sure that you generate loans. But in order to recruit those top performing SBA BDOs, you will need to show them that you have a way of getting their loans closed quickly.
The most effective solution for solving these problems is to hire a quality SBA Lender Service Provider (LSP). This is the quickest way to add an experienced SBA back shop that will warranty its work and handle the loan eligibility determination, underwriting, processing, closing, loan sale and servicing. This gives the bank a variable cost solution, and allows them to have personnel to process 100s of loans per year. While some of the better LSPs will help the lender with the underwriting of the loan, it is solely the bank that makes the credit approval decision. SBA outsourcing is very cost effective and allows a bank to begin participating and making money with these programs immediately, even if they only do a few loans.
Making a Profit Let us look at the bank’s profits from a $1.0 million SBA 7(a) loan that is priced at prime plus 2.0 percent with a 25-year term.
Gain on the sale of the SBA guaranteed portion
(12% net 14% gross)
Net interest income(5.25%-0.75% COF = 4.5%)
(NII on $250,000)
Servicing Income ($750,000 X 1.0%)
Total gross income
Loan acquisition cost (assumed to be 2.5%)
(BDO comp, etc.)
Outsource cost (approximately 2.0%)
(per SBA guidelines)
Annual servicing cost (assumed to be 0.50%)
Loan loss provision (2.0% of $250,000)
Net pretax income
ROE ($53,750/$25,000 risk based capital)
In this example the bank made a $1.0 million SBA loan and sold the $750,000 guaranteed piece and made a $90,000 gain on sale. The bank earned $11,250 of net interest income on the $250,000 unguaranteed piece of that loan that the bank retained. When an SBA guaranty is sold, the investor buys it at a 1.0 percent discount, so the lender earns a 1.0 percent ongoing fee on the guaranteed piece of the loan for the life of the loan. This example did not account for the amortization of the loan through the year.
I believe that the expenses are self explanatory, but you can see if the bank made $20 million of SBA loans using these assumptions, they would earn $1.075 million in the first year.
Conclusion As you can see, SBA lending can add a substantial additional income stream to your bank; however, you need a certain amount of loan production and a high quality staff, or you need an SBA outsource solution to underwrite and process the loans. As you can see, the ROE and ROA for SBA loans is much higher than conventional financing, which is why you see community banks that have an SBA focus generate higher returns.
The banking industry in general seems to be doing quite well, thank you. Profitability has risen in the past year. Banks overall have seen 20 straight quarters of improved credit quality. Loan growth is picking up. So all is good, right?
Investment bankers and attorneys speaking Sunday at Bank Director’s Acquire or Be Acquired Conference in Scottsdale, Arizona, said yes, but with big qualifiers. The benefits of an improved market have not been equally shared. Some banks are doing better than others. And low interest rates are putting pressure on banks to sell.
Small and mid-sized banks, those with less than $50 billion in assets, are actually outperforming the bigger banks, said Tom Michaud, the chief executive officer at investment bank Keefe, Bruyette & Woods. The sweet spot seems to be banks between $5 billion and $50 billion in assets. Their profitability metrics are higher, they are growing loans at a faster pace, and they command higher pricing multiples compared to bigger banks, he said. Part of that is the sheer size of the regulatory fines bigger banks are still getting hit with, seven years after the start of the financial crisis. Plus, big, global banks must maintain higher capital levels than smaller banks, which impacts their profitability. “The small-cap banks grow faster,” said Michaud, and on a relative basis, “they earn more money.’’
But small cap is a relative term. Many of those attending the conference are directors or officers at banks below $1 billion in assets, and for them, pricing multiples can be a challenge unless they are in a good growth market and have strong earnings.
Those bank boards that manage to sell their banks at 1.5 to 2 times book value tend to be high earning banks with high loan to deposit ratios in or near a metro area, where much of the loan growth is occurring in the country, not in a rural area, says Curtis Carpenter, managing director at Sheshunoff & Co. Investment Banking. Size also matters. The median asset size for a bank that sold at two times adjusted book value since 2013 was $917 million, versus $213 million for a bank that sold at 1 to 1.25 times book, he said.
“Larger banks tend to be more profitable, but even more so, bigger sellers tend to attract bigger buyers,’’ he said.
Smaller banks are often less profitable and less efficient than bigger banks, which is leading some of them to sell to larger entities, especially since pricing for deals has improved in the last year, so they can make more money when they sell their banks than they could in prior years. Interest rates have stayed down longer than many predicted, which has kept pressure on net interest margins, the key metric for most community banks, which rely on loans to generate earnings. Low interest rates may also lead to more consolidation going forward, as banks search for better efficiency and growth through acquisitions.
“The reality is organic growth is tough,’’ said Chris Myers, the president and CEO of the $7.2-billion Citizens Business Bank in Ontario, California, who spoke at the conference. His bank is one of those in the “sweet spot” for higher valuations and higher profitability, but even he feels the pressure to grow. “A lot of banks are stretching to try to grow [loans] and do things they wouldn’t have done in the past,’’ he said, commenting on the competition for good loans. “ We are going to need to do some acquisitions.”