Competition for Credit Analysts Creating New Challenge for Banks


analyst-5-3-18.pngSuccessfully recruiting a qualified credit analyst is proving to be quite a challenge in today’s banking environment. There are a number of contributing factors, including compensation compared to other industries, the evaporation of commercial credit training, and a lack of college graduates in certain areas.

With this shortage, credit analysts are highly sought after, and analysts are demanding higher wages than what the banking industry is accustomed to paying.

In the past, it has been common practice for banks to outsource loan review, compliance testing, and internal audit functions — so why not the credit analyst role?

Thin talent pools flow two ways
Historically, banks have hired recent college graduates as credit analysts with the expectation of developing them into commercial lenders and potentially future management. In theory, this practice makes sense. But in today’s market, the success rate of banks converting a credit analyst into a long-term employee seems to be the exception rather than the norm, causing many banks to abandon their commercial training programs.

Over the past decade, many banks have begun hiring seasoned credit analysts who aren’t looking to move to a customer-facing role, making it more difficult to find affordable, permanent analysts.

In recent years, outsourced providers have started meeting the demand for credit analysts. With the increase in compensation for this role, outsourcing may now be the cost-effective option. This is especially true when you factor in the time and effort spent recruiting and training, while accounting for increased efficiency or production from an experienced analyst/outsourced provider.

Banks Still Have Underwriting Control
It is clear many bankers do not want an outside vendor impacting their underwriting decisions. Banks want to make loans to familiar borrowers, and they don’t want the potential for an overly critical or negative analysis from a third party to hinder their ability to do so.

It’s important to understand that your bank will always own and control the underwriting process. The primary focus for outsourced credit analyst services is to provide all the relevant credit information in a consistent format, which will allow the bank to make a well-informed decision. Outsourcing credit analysis should not impact the bank’s underwriting practices.

Banks take pride in their ability to provide quick responses to their borrowers. Outsourcing analyst work doesn’t mean longer turnaround times. If you are considering an outsourced solution, make sure that you establish clear deadlines with your vendor.

You could also consider segmenting the credit analyst work flow between new credit requests and ongoing portfolio monitoring. It may make sense for a bank to analyze new money requests in-house, and then to outsource the less time-sensitive renewal requests and annual reviews.

Training, Retaining Analysts Can Cost You
Even if you are successful in hiring a qualified analyst candidate, the time and resources needed to properly train a new hire with little or no previous credit experience can be quite extensive. Typically, when a bank is large enough to have a pool of credit analysts, there is usually a full-time employee who helps train and develop their skill set. But if you work at a smaller community bank, you might only have one or two analysts on staff.

It is common for a senior analyst, credit officer, or a manager from the credit administration area to oversee a new analyst. But these employees usually maintain a full workload in addition, which may result in inadequate training, or an overstressed manager.

The challenge doesn’t end once you hire and train a new credit analyst. One of the biggest challenges still remains — keeping the analyst in the role. Most banks are lucky if they can keep an analyst in the role for two or three years before the individual leaves for higher pay or a more satisfying analyst role somewhere else. And then it’s time to start the recruiting and training process all over again.

At the end of the day, banks want a viable option to end the what seems like a revolving door of credit analysts. By outsourcing this role, banks have new opportunities to provide cost savings and improve quality for their customers.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. For more information, visit CLAconnect.com.

How to Pick the Right Digital Small Business Lending Tool: Top 10 Must Have Characteristics


lending-4-24-17.pngHaving access to online lending applications has quickly transitioned from a customer convenience to a customer expectation. It’s only a matter of time before all institutions will be providing digital access to small business lending. That much is certain. What isn’t certain is how to find the right fintech partner. Your partner should understand your institution’s lending processes and digital strategy in that space, and provide you with a solution that meets your unique objectives.

Here are the top 10 characteristics you should demand from any digital business lending partner.

1. Friend Not a Foe Business Model
It’s obvious, I know, but find a partner who is not a competitor of yours. There are business lending fintech companies that once had designs on putting banks and credit union lending departments out of business. If the businesses you serve can also go to your partner’s website and apply directly with them for a loan, they’re not a partner. They are a competitor.

2. Timely End-to-End Functionality
Current business lending processes are onerous for both the client and the bank. Applications are submitted incompletely 60 percent of the time, and data is bounced from one party to another and back again. Technology does an amazing job of doing things right the first time every time. The value in your business lending tool resides in its ability to help facilitate everything from the application to closing the loan.

3. Endorsed by a Trusted Source
Most of the financial services industry’s trusted resources and trade associations provide their members with a list of solutions for which they have completed comprehensive due diligence and identified as an endorsed solution. Entities, like the American Bankers Association, Consumer Bankers Association and others, have the resources to conduct due diligence on the companies they recommend. Leverage their expertise.

4. Control…Control…Control
The institution must be able to retain control over every aspect of the process. Your clients should never even know the tech partner exists. The brand, the credit policy, pricing, scoring, decisions, and all aspects of the customer relationship must be fully owned and controlled by the institution.

5. Customer Experience
Find a tech partner that shares your philosophy of putting the borrower at the center of the process. Look for a tool that creates an engaging, simple, and even fun environment for the application portion of the process, and results in a speedier, more efficient and convenient end-to-end process.

6. Enhances Productivity
Find tech that frees up your sales staff to sell, and allows your back office to spend minutes—not hours—making a decision on a business loan. Sales teams should spend their time growing relationships and sourcing new deals as opposed to shepherding deals through the process or chasing documentation. With the right tool, back office can analyze deals quickly and spend more time on second look processes or inspecting larger deals.

7. Builds the Loan Portfolio
Find a tech solution so good that it will draw new opportunities into your shop—even those folks who would never think about walking into a branch. And make sure the application process can accommodate both the borrower who is online and independent, as well as the borrower who wants to sit next to a banker and complete the application together.

8. The Human Touch
The most important relationship is the one between banker and customer. Don’t lose the personal touch by using technology that cuts out the value the banker brings to the relationship. Instead, find a tool that engages the relationship managers and facilitates their trusted advisor status.

9. Positive Impact on Profitability
By finding a tool that enhances productivity across the board, you should be able to reduce cost-per-loan booked by as much as two-thirds. That means even the smallest business loans should be processed profitably.

10. Cloud-Based Model
The best way to keep pace with innovation in a cost-effective manner is to find a partner that uses the latest technology, development processes and a cloud-based model, which enhances storage capabilities. Your partner should update and enhance often, and not nickel and dime you for every enhancement or upgrade.

Stick to these guidelines and you’ll be sure to find the right tool for your unique institution.

To Better Understand Bank Real Estate Credit Concentrations, Give Your Portfolio a Workout


stress-test-4-19-17.pngBy now, the vast majority of banks with credit concentrations in excess of the 2006 Interagency Regulatory Guidance have discussed this with regulators during periodic reviews. To underscore the importance of this to the regulators, a reminder was sent by the Federal Reserve in December of 2015 about commercial real estate (CRE) concentrations. The guidance calls for further supervisory analysis if:

  1. loans for construction, land, and land development (CLD) represent 100 percent or more of the institution’s total risk-based capital, or
  2. total non-owner-occupied CRE loans (including CLD loans), as defined, represent 300 percent or more of the institution’s total risk-based capital, and further, that the institution’s non-owner occupied CRE loan portfolio has increased by 50 percent or more during the previous 36 months.

While the immediate consequence of exceeding these levels is for “further supervisory analysis,’’ what the regulators are really saying is that financial institutions “should have risk-management practices commensurate with the level and nature of their CRE concentration risk.” And it’s hard to argue with that considering that, of the banks that met or exceeded both concentration levels in 2007, 22.9 percent failed during the credit crisis and only .5 percent of the banks that were below both levels failed.

So the big question is: How to mitigate the risk? Just like the idea of having to fit into a bathing suit this summer can be motivation to exercise, the answer is to give your loan portfolio a workout.

And in this context, that workout should consist of stress testing designed to inform and complement your concentration limits. In other words, the limits you set for your bank should not exist in a vacuum or be made up from scratch, they need to be connected to your risk management approach and more specifically, your risk-based capital under stress. What’s necessary is to take your portfolio, simulate a credit crisis, and look at the impact on risk-based capital. How do your concentration limits impact the results?

For our larger customers, we find that a migration-based approach works best because the probability of default and loss given default calculations can come from their own portfolio and they can be used to project forward in a stress scenario (1 in 10 or 1 in 25-year event, for example). For our smaller banks or banks that do not have the historical data available, we use risk proxies and our own index data to help supplement the inevitable holes in data. Remember, the goal is to understand how the combination of concentrations and stress impacts your capital in a data-driven and defensible way.

Additionally, the data repository created from the collection of the regulatory flat files (the only standardized output from bank core systems) can be used for a variety of purposes. This data store can also be used to create tools for ongoing monitoring and management of concentrations that can include drill down capabilities for analysis of concentrations by industry, FFIEC Code, product/purpose/type codes, loan officer, industry and geography (including mapping), and many others. The results of loan review can even be tied in. The net result is a tool that provides significant insight into your portfolio and is a data-driven road map to your conversation with your regulators. It also demonstrates a bank’s commitment to developing and using objective analytics, which is precisely the goal of the regulators. They want banks to move past the days of reliance on “gut feel” and embrace a more regimented risk management process.

When the segmentation and data gathering is done well, you are well positioned to drive your portfolio through all sorts of different workouts. The data can be used for current allowance for loan and lease losses, stress testing, portfolio segmentation, merger scenarios and current expected credit loss (CECL) calculations, as well as providing rational, objective reasons why concentration limits should be altered.

And just like exercise, this work can be done with a personal trainer, or on your own. All you need is a well thought out plan and the discipline to work on it every day as part of an overall program designed for credit risk health.

Using Big Data to Assess Credit Quality for CECL


CECL-4-7-17.pngThe new Financial Accounting Standards Board (FASB) rules for estimating expected credit losses presents banks with a wide variety of challenges as they work toward compliance.

New Calculation Methods Require New Data
The new FASB standard replaces the incurred loss model for estimating credit losses with the new current expected credit loss (CECL) model. Although the new model will apply to many types of financial assets that are measured at amortized cost, the largest impact for many lenders will be on the allowance for loan and lease losses (ALLL).

Under the CECL model, reporting organizations will make adjustments to their historical loss picture to highlight differences between the risk characteristics of their current portfolio and the risk characteristics of the assets on which their historical losses are based. The information considered includes prior portfolio composition, past events that affected the historic loss, management’s assessment of current conditions and current portfolio composition, and forecast information that the FASB describes as reasonable and supportable.

To develop and support the expected credit losses and any adjustments to historical loss data, banks will need to access a wider array of data that is more forward-looking than the simpler incurred loss model.

Internal Data Inventory: The Clock is Running
Although most of the data needed to perform these various pooling, disclosure and expected credit loss calculations can be found somewhere, in some form, within most bank’s systems, these disparate systems generally are not well integrated. In addition, many data points such as customer financial ratios and other credit loss characteristics are regularly updated and replaced, which can make it impossible to track the historical data needed for determining trends and calculating adjustments. Other customer-specific credit loss characteristics that may be used in loan origination today might not be updated to enable use in expected credit loss models in the future.

Regardless of the specific deadlines that apply to each type of entity, all organizations should start capturing and retaining certain types of financial asset and credit data. These data fields must be captured and maintained permanently over the life of each asset in order to enable appropriate pooling and disclosure and to establish the historical performance trends and loss patterns that will be needed to perform the new expected loss calculations. Internal data elements should focus on risks identified in the portfolio and modeling techniques the organization finds best suited for measuring the risks.

External Economic Data
In addition to locating, capturing, and retaining internal loan portfolio data, banks also must make adjustments to reflect how current conditions and reasonable and supportable forecasts differ from the conditions that existed when the historical loss information was evaluated.

A variety of external macroeconomic conditions can affect expected portfolio performance. Although a few of the largest national banking organizations engage in sophisticated economic forecasting, the vast majority of banks will need to access reliable information from external sources that meet the definition of “reasonable and supportable.”

A good place to start is by reviewing the baseline domestic macroeconomic variables provided by the Office of the Comptroller of the Currency (OCC) for Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank stress testing (DFAST) purposes. Because regulators use these variables to develop economic scenarios, these variables would seem to provide a reasonable starting point for obtaining potentially relevant historic economic variables and considerations from the regulatory perspective of baseline future economic conditions.

Broad national metrics—such as disposable income growth, unemployment, and housing prices—need to be augmented by comparable local and regional indexes. Data from sources such as the Federal Deposit Insurance Corporation’s quarterly Consolidated Report of Condition and Income (otherwise known as the call report) and Federal Reserve Economic Data (FRED), maintained by the Federal Reserve Bank of St. Louis, also can be useful.

Data List for CECL Compliance

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Looking Beyond Compliance
The new FASB reporting standard for credit losses will require banks to present expected losses in a timelier manner, which in turn will provide investors with better information about expected losses. While this new standard presents organizations of all sizes with some significant initial compliance challenges, it also can be viewed as an opportunity to improve performance and upgrade management capabilities.

By understanding the current availability and limitations of portfolio data and by improving the reliability and accuracy of various data elements, banks can be prepared to manage their portfolios in a way that improves income and maximizes capital efficiency.

Beating SMB Alt Lenders at Their Own Game


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Small businesses are an important segment for banks and credit unions with aggressive growth goals. In the United States, small businesses make up 99.7 percent of employer firms, according to the SBA FAQ Sheet. The top concern for these firms is managing their cash flow needs, which creates a great lending opportunity for banks and credit unions. Unfortunately, it can be a difficult opportunity for them to take advantage of because of their antiquated processes.

As Steven Martin, vice president of strategy at Sageworks, discussed during a recent webinar, the demographic composition of small business owners is shifting away from baby boomers and towards Gen X’ers and millennials. These younger business owners are more tech-savvy than their parents. They are more used to shopping online, including for credit and financing solutions. Additionally, many small business owners are too busy running their businesses to leave to visit a branch to begin the application process. When these small business owners go online looking for loans, they find that over 80 percent of banks and credit unions do not offer a way to apply for a loan online. This causes many small business owners to turn to alternative lenders for credit. These “alt lenders” can provide the funds faster and offer an end-to-end online experience. The number of small business owners who turn to alt lenders instead of banks and credit unions is growing. If financial institutions want to preserve and grow their SMB lending business, they will need to revisit two aspects of their loan origination strategy.

Small business borrowers deserve a better experience
Slow and complex loan application processes at many financial institutions frustrate small business borrowers. On average, an application for a small business loan takes two to four weeks. By the time borrowers submit an application, they have already spent an average of 26 hours researching capital options. Once borrowers decide they are ready to apply for a loan, they do not want to spend weeks waiting to receive their funding.

Many of the alternative online lenders charge much higher interest rates than banks and credit unions, yet, business borrowers short on time are increasingly willing to pay more in fees or interest rates to fix their cash flow problem.

Additionally, the difficulties of traveling to a branch and chasing hard copies of documents make the application process even more tedious. Improving the borrower experience is critical for banks and credit unions that want to grow their SMB portfolios.

Costly origination of SMB loans
A second challenge to growing the SMB portfolio is the cost of originating small loans. On average, the cost to originate a small business loan is almost as high as the cost to originate a much larger loan. The lower profits on smaller loans means that many banks and credit unions struggle with achieving sufficient profitability on SMB loans.

However, simply ignoring the SMB market narrows the institution’s opportunity to grow. Also, banks that already have a depository relationship with a small business may risk the entire relationship if they can’t provide a loan.

How then to increase profitability of small business lending?

First, the institution can reduce costs by making the job easier for lenders. Leveraging tools such as an online loan application, which allows borrowers to enter their information and submit documents online, saves loan officers the time of tracking down all the necessary documentation. Institutions can also reduce the time analysts spend entering data by utilizing a tool such as the Sageworks Electronic Tax Return Reader. The ETRR reads and imports data from the borrower’s tax return into the spreading software.

Another major cost of loan origination is the time spent analyzing and decisioning a loan, and automated tools can help here as well. For example, a bank that specializes in agricultural lending may be very familiar with equipment loans. This bank could see significant time savings by implementing loan decisioning software that can be tailored to its risk appetite for ag loans. The bank sets the required metrics and approval criteria, and the software provides a recommendation on the loan. This allows analysts to enter less information and make a faster decision while maintaining pre-existing credit standards.

Small business lending is an important segment for growth-minded banks and credit unions. However, frustrating borrower experiences and expensive application processes make it difficult for many institutions to build profitable SMB lending programs. By leveraging technology to improve the borrower experience and increase profitability for the institution, banks and credit unions can build a path to growth with business lending.

How Fintech Can Improve the Customer Experience in Construction Lending


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One of the most underserved areas in financial technology is construction lending, which exposes banks and non-bank lenders to unnecessary risk, costs shareholders money and negatively impacts the client experience for borrowers. For an asset class that is finally gaining steam after punishing many lenders during the Great Recession, this is an area that can’t be ignored.

The problem? Once a construction loan closes, it’s booked into a loan servicing system. But to be properly serviced, that requires paper files, spreadsheets, emails and phone calls between lender staff, borrowers, builders, draw inspectors (people who go out to the job site and validate that the work is being done before a bank can release loan funds from a draw request) and title companies throughout the construction period. This coordination between parties is critical for lenders to mitigate risk and ensure that every dollar is actually going into their collateral. However, this reactive rather than proactive process is not only slow and costly, but it prevents even the most sophisticated internal systems from providing lenders with real-time visibility into what’s going on, much less their clients.

The concept of applying technology to a problem within lending in order to greatly reduce risk, increase transparency, eliminate friction, improve the customer experience and drive cost savings did not make its way into construction lending until recently. Most lenders don’t realize there is a better way.

This is the perfect example of how fintech can help solve a problem faced by banks and non-bank lenders alike.

Where Fintech Can Help

Risk: Construction loans are often perceived as the riskiest loans in a bank’s portfolio. As such, they garner significant attention from regulatory agencies that want to ensure risk is being properly managed. Technology applied to construction lending allows key information to be transparent and consumable in real-time. This reduces the opportunity for human error, ensures loans aren’t being overfunded and helps a lender maintain a first lien position throughout the life of a construction project. And perhaps the most exciting byproduct of bringing these loans into the digital world is the data. Analytics can now be used to help lenders make better decisions about the loans they make as well as proactively manage risk in their active portfolio. For instance, imagine proactive notifications to alert appropriate lender personnel that a construction project has gone stale or that a borrower has materially changed their behavior based on historical data.

Efficiency: Construction loans require more post-closing support and ongoing administration effort to be properly serviced than any other type of lending. While critical, this effort costs lenders more money than they likely realize. By bringing collaboration and automation into construction lending, lenders can now connect with their borrowers, builders, draw inspectors, and others in real-time, allowing each party to push things forward while knowing where (and with whom) things stand in the process. This eliminates countless steps and saves everyone significant time. Not only does this improve a lender’s efficiency, but it also gets borrowers their money safer and faster–creating happier builders and allowing lenders to accrue more interest.

Customer Experience: Today, the customer experience for a borrower managing a construction loan is sadly lacking. If a borrower or builder wants to make a draw on their loan, or wants to know where a loan currently stands, it requires a phone call or an email to their lender. This triggers a domino effect of events that usually results in stale information and disrupts the lender’s workflow. Through technology, borrowers and builders have full transparency into what’s going on, and can often self-serve from their phone or computer. That ends up being a better customer experience even though there is no human-to-human contact. Technology also means faster access to draws, which means that projects can be pushed forward faster.

The best part is that with the right technology solution, lenders don’t have to choose which of these three areas is most important because they can have their cake and eat it too. As with most areas of the financial services industry, fintech’s introduction to construction lending is changing everything for the better.

Why Every Basis Point Matters Now


derivatives-2-17-17.pngAfter eight years of waiting for interest rates to make a meaningful move higher, the fed funds rate is making a slow creep towards 2 percent. With a more volatile yield curve expected in the upcoming years and continued competition for loans, net interest margins (NIM) may continue to compress for many financial institutions. The key to achieve NIM expansion will involve strong loan pricing discipline and the full toolkit of financial products to harvest every available basis point.

Where to look on the balance sheet? Here are some suggestions.

Loan Portfolio
The loan portfolio is a great place to look for opportunities to improve the profitability. Being able to win loans and thus grow earning assets is critical to long-term success. A common problem, however, is the mismatch between market demand for long-term, fixed rate loans and the institution’s reluctance to offer the same.

Oftentimes, a financial institution’s interest rate risk position is not aligned to make long-term, fixed rate loans. A few alternatives are available to provide a win-win for the bank and the borrower:

  • Match funding long-term loans with wholesale funding sources
  • Offer long-term loans and hedge them with interest rate swaps
  • Offer a floating rate loan and an interest rate swap to the borrower and offset the interest rate swap with a swap dealer to recognize fee income upfront

With the ability to offer long-term fixed rate loans, the financial institution will open the door to greater loan volumes, improved NIM, and profitability.

How much does a financial institution leave on the table when prepayment penalties are waived? A common comment from lenders is that borrowers are rejecting prepayment language in the loan.

How much is this foregone prepayment language worth? As you can see from the table below, for a 5-year loan using a 20-year amortization, the value of not including prepayment language is 90 basis points per year.

Swap-chart.PNG

At a minimum, financial institutions should look to write into the loan at least a 1- to 2-year lock out on prepayment, which drops the value of that option from 90 basis points to 54 basis points for a 1-year lock out or 34 basis points for a 2-year lock out. That may be more workable while staying competitive.

Investment Portfolio
The investment portfolio typically makes up 20 percent to 25 percent of earning assets for many institutions. Given its importance to the financial institution’s earnings, bond trade execution efficiency may be a way to pick up a basis point or two in NIM.

A financial institution investing in new issue bonds should look at the prospectus and determine the underwriting fees and sales concessions for the issuance. There are many examples in which the underwriting fees and sales concessions are 50 to 100 basis points higher between two bonds from the same issuer with the same characteristics, with both issued at par. To put that in yield terms, on a 5-year bond, the yield difference can be anywhere between 10 and 20 basis points per year.

If you are purchasing agency debentures in the secondary market, you can access all the information you need from the Financial Industry Regulatory Authority’s Trade Reporting and Compliance Engine (TRACE) to determine the mark up of the bonds you purchased. Using Bloomberg’s trade history function (TDH), in many cases, it is easy to determine where you bought the bond and how much the broker marked up the bond. Similar to the new issue example above, a mark-up of 25 to 50 basis points more than you could have transacted would equate to 5 to 10 basis points in yield on a 5-year bond.

For a typical investment portfolio, executing the more efficient transactions would increase NIM by 1.5 to 5 basis points. For many institutions, simply executing bond transactions more efficiently equates to a 1 percent to 3 percent improvement in return on assets and return on equity.

Wholesale Funding
A financial institution can use short-term Federal Home Loan Bank (FHLB) advances combined with an interest rate swap to lock in the funding for the desired term. By entering into a swap coupled with borrowing short-term from the FHLB, an institution can save a significant amount of interest expense. Here is an example below:

borrowing-chart.PNG

Derivatives
As you can see from a few of the previous examples, derivatives can be useful tools. Getting established to use derivatives takes some time, but once in place, management will have a tool that can quickly be used to take advantage of inefficient market pricing or to change the interest rate risk profile of the institution.

Number of Community Banks Using Derivatives, by Year

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Conclusion
In a low interest-rate environment and with increased volatility in rates across the yield curve, net interest margins are projected to continue to be under pressure. The above suggestions could be crucial to ensuring long-term success. Offering longer-term loans and instilling more efficient loan pricing is the start to improved financial performance.

The Perfect Complement: Community Banks and Alternative Lenders


lenders-2-8-17.pngArmed with cost and process efficiency, greater transparency, and innovative underwriting processes, alternative lenders are determined to take the lending space by storm. Alternative small business lenders only originated $5 billion and had a 4.3 percent share of the small business lending market in the U.S. in 2015. By 2020, the market share of alternative lenders in small business lending in the U.S. is expected to reach 20.7 percent, according to Business Insider Intelligence, a research arm of the business publication.

Being able to understand customer-associated risk by relying on alternative data and sophisticated algorithms allowed alternative lenders to expand the borders of eligibility, whether for private clients or small businesses. In fact, a Federal Reserve survey of banks in 2015 suggests that online lenders approved a little over 70 percent of loan applications they received from small-business borrowers—the second-highest rate after small banks, which approved 76 percent, and much higher than the 58 percent approved by big banks.

Coming so close in approval rates to banks and having lent billions employing a different, more efficient business model inevitably created an interest from banks. Some of the largest institutions have been taking advantage of the online lenders’ technology, but community and regional banks are still in the early stages of exploring partnership opportunities. While concerns over those types of partnerships are understandable, there are also important positive implications, which we will explore further.

Cost-Efficient Capital Distribution Channel
Online marketplaces represent an additional, cost-efficient channel for capital distribution, expanding the potential customer base. An opportunity to grow loan portfolios with minimal overhead and without the need for adoption or development of resource-consuming technology, led to a partnership between Lending Club and BancAlliance, a nationwide network of about 200 community banks. The partnership allowed banks to have a chance at purchasing the loans originated by Lending Club, and, in case those loans did not meet the requirements, they were offered to a larger pool of investors. Banks also have an opportunity to finance loans from a wider Lending Club portfolio.

Examples of partnerships also include Prosper and the Western Independent Bankers. These partnerships give more banks an opportunity to offer credit to their customers, and more consumers access to affordable loans.

Portfolio Diversification and Customer Base Expansion
Alternatives lenders can offer an easy application process, a quick decision and rapid availability of funds due to an alternative approach to the underwriting process. Use of alternative data to assess creditworthiness is an inclusive approach to loan distribution. In 2015, in the U.S., there were 26 million credit invisible consumers. Moreover, the Consumer Financial Protection Bureau suggests that 8 percent of the adult population has credit records that you can’t score using a widely-used credit scoring model. Those records are almost evenly split between the 9.9 million that have an insufficient credit history and the 9.6 million that lack a recent credit history.

Paul Christensen, a clinical professor of finance at Northwestern University’s Kellogg School of Management, believes there are positive implications for companies leveraging alternative data to make a credit decision.

“For companies, alternative credit rating is about reducing transaction costs. It’s about figuring out how to make profitable loans that are also affordable for most people—not just business owners,” he said in a September 2015 article.

For community banks, as regulated institutions, partnerships with alternative lenders that extend credit to parts of the population perceived as not creditworthy is an opportunity to reach new consumer segments and contribute to inclusive growth and resilience of disadvantaged households.

Customer Loyalty
Two Federal Reserve researchers noted in a 2015 paper that community banks can increase customer loyalty by referring customers to alternative lenders when banks cannot offer a product that meets the customer’s needs. “By providing customers with viable alternatives? it is more likely that these customers will maintain deposit and other banking relationships with the bank and return to the bank for future lending needs,” the researchers emphasized.

Access to Knowledge, Expertise and Technology
While the extent of integration may vary, one of the most important elements of partnerships that carry long-term organizational and industry benefits is mutual access to knowledge, expertise and technology. The combination of banks’ and alternative lenders’ different business models with an understanding of mutual strengths allows the whole industry to transform and provide the most efficient, consumer-facing model.

Finding Loans in All the Right Places


loan-growth-11-17-16.pngPennsylvania, 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 Little Bank That Could


strategy-9-23-16.pngSoon after Josh Rowland’s family bought Lead Bank in Garden City, Kansas, in 2005, the small financial institution felt the full impact of the financial crisis. The loan portfolio was in bad shape. Several employees lost their jobs. The entire experience lead to a lot of soul searching.

“It was really existential,’’ Vice Chairman Rowland says. “What do we survive for? What’s the point of a community bank? The situation was that dire. We had to really decide whether we should give it up.”

After much discussion, the family decided to hire Bill Bryant as the chief executive officer to help clean up the bank, now with $164 million in assets, and really focus on its niche: small business owners. A lot of community banks say they are serving small business owners, but Lead Bank decided to go a step further. In 2011, it launched a business advisory division for the purpose of coaching small business owners on cash flows, provide part-time or interim chief financial officers, and advice on strategic planning and even mergers and acquisitions. Rowland says a lot of small businesses could use advisory services, especially if they can’t afford to hire a full-time CFO. Lead Business Advisors has senior managing director Patrick Chesterman, a former energy executive for a large propane company and Jacquie Ward, a trainee analyst. The bank overall made a profit of $500,000 in the first six months of the year and saw assets grow 30 percent in the last year and a half, according to Federal Deposit Insurance Corp. data.

But the investment in advisory services is not a quick payback. Rowland says the division is not profitable yet. The challenges include marketing the program to a business community more accustomed to relying on trusted accountants or lawyers for such advice. Banks naturally have a lot of financial information and expertise, but they fail to provide it to their clients. “We ought to be figuring out every possible way to deliver that kind of financial expertise to Main Street business,” he says.

The tactic is an unusual one for community banks, which might have a wealth management division but not a business advisory division per se. And it’s expensive. Baker Boyer, a $571 million bank in Walla Walla, Washington, has been offering business advisory services as part of its wealth management division for years. But it has taken some 15 years to restructure the bank to offer such services, says Mark Kajita, president and chief executive officer. The average personnel expense per employee for the bank is roughly $80,000 annually with six lawyers on staff and the bank’s efficiency ratio is 73 percent, higher than the peer average of 66 percent.

However, the bank made $2.5 million in profits during the first half of 2016, with half of that coming from the wealth and business advisory division. Kajita says what made it possible was the fact that the bank is family owned and can invest in the long term without worrying about reporting quarterly financial results to pubic shareholders.

Community banks of that size have a real need to create a niche,’’ says Jim McAlpin, a partner at Bryan Cave in Atlanta who advises banks. “Historically, community banks have been focused on the small businesses of America, and to offer services to those small businesses is a great strategy.”

Joel Pruis, a senior director at Cornerstone Advisors in Phoenix, says banks have done themselves a disservice by relinquishing advisory services to CPAs and attorneys. “In terms of empowering lenders, in terms of providing more advice, we definitely need more of that,’’ he says. “Bankers need to be seen as a resource and an expert in the financial arena instead of just application takers.”

For Rowland, rethinking the role of the community bank is fundamental to its survival. “I don’t know how we expect to keep doing the same things and expect different results,’’ he says. People don’t feel their bank is adding any value for them, he says. “If that’s our industry’s problem that we haven’t given them an experience, that’s our fault,’’ Rowland says. “We have taught them over years and years that our services are so cheap, they ought to be free.”