Cash for Truckers Turns Into Cash for Bankers


specialty-finance-7-15-16.pngCash4truckers.com* sounds like something you’d see on a roadside billboard, not a message coming from a community bank. In fact, the domain name is owned by Triumph Business Capital, a subsidiary of a $1.7 billion asset community banking company named Triumph Bancorp in Dallas, Texas.

“You’d have no idea it was a bank,’’ Triumph Bancorp Vice Chairman and CEO Aaron Graft said about the web site at a recent Bank Director conference. “We don’t wait for a customer to show up in one of our primary markets.”

Triumph Business Capital, then known as Advance Business Capital, was founded in 2004 and sold to a group of Dallas area investors in 2012 led by Graft. Triumph has very little presence in the Dallas market where it is headquartered but has 40 percent of its loan portfolio in specialty finance nationwide. It is doing something unusual for a community bank. It’s trying to compete in the realm of factoring and asset-based lending for small businesses, including construction, transportation and trucking businesses as small as one guy with his one truck. Triumph will buy an invoice from a trucker, for example, charging 1.5 or 2 percent of the size of the invoice. That has helped the bank achieve an adjusted net interest margin of 5.61 percent, 203 basis points higher than the average for banks $1 billion to $10 billion in asset size, according to data from the Federal Deposit Insurance Corp.

The trucker gets the cash and Triumph pursues collection from the customer who received the shipment. So the credit risk is analyzing whether or not the customer, not the trucker, will pay the bill. The trucker also gets additional services including discount fuel cards as well as having someone else manage invoices while they’re on the road.

Not a lot of banks want to get into this business. Larger companies are able to finance their working capital needs through the likes of big banks such as CIT Group. Small businesses take just as much work as the big companies to finance, but the loans are smaller. Many small banks don’t want to invest in that type of lending because it requires so much expertise to manage and keep track of the loans.

This is where Triumph comes in. “We are willing to serve the smaller end of the market because we think they need it more and because we think that’s where the opportunity is,” says Graft.

It’s a strategy born in an age of slow growth and low interest rates, where banks are scrambling to grow loan portfolios and profits. The Office of the Comptroller of the Currency recently warned in its semi-annual risk report that growing competitive pressures have led to lowering underwriting quality and increased credit risk.

Graft says he’s dealing with the risk inherent in his strategy by bulking up his specialty finance staffing and expertise. As an example, more than 100 people work in factoring with a loan book of about $150 million. The bank reviews invoices for fraud, hoping to catch people submitting false invoices. Graft says he’s dealing with regulatory risk by communicating the bank’s strategy to regulators, to serve both as a community bank and as a national specialty finance company. The bank’s subsidiaries offer business-related services such as treasury management and insurance, as well as branch banking through Triumph Community Bank in the Chicago area. Triumph also announced plans in March to purchase a bank based in Lamar, Colorado, with $759 million in assets and 17 branches, which will make Triumph a $2.5 billion asset holding company.

“It’s a little outside the box,’’ says stock analyst Brad Milsaps of Sandler O’Neill + Partners, who covers the bank. He says Triumph is growing by buying community banks to acquire deposits and use those deposits to lend nationally. The bank’s return on assets was 1.20 percent in the first quarter, up from 1.10 percent in the same quarter a year ago, but some of that was the impact of bargain purchase gains from acquisitions, Milsaps says. “They’ve got the operational controls and experience in that business to hopefully mitigate the risk,’’ he says. “If you don’t have the systems and people in place in that space, you’ll get burned very, very quickly.”

*Note: Triumph owns cash4ftruckers.com but has begun redirecting viewers to invoicefactoring.com. Cashfortruckers.com has a similar name but is owned by a different company.

The Breakdown of What SBA Lending Can Do For Your Bank


sba-lending-6-29-16.pngIn today’s challenging banking market, community banks are always looking for ways to increase profits, minimize expenses and diversify their loan portfolios. One solution many banks are utilizing is to add an SBA lending department into their mix of loan products.

The primary SBA lending program is the SBA 7(a) loan program, which allows the bank to make small business loans and receive a 75 percent guarantee from the U.S. government. The guaranteed portions of these loans can be sold in a secondary market, with current gain on sale premiums of 13.5 percent net to the bank.

SBA lending is not only a great way to increase the number of business clients that your bank can serve, but can also be very profitable.

Profitability Model
Let’s assume that you hire your underwriting and processing staff and the lending staff brings in $10 million in SBA loans. If the bank sells the 75 percent portion of the loans that is guaranteed, or $7.5 million, it should earn at least a 12 percent premium in today’s market, or $900,000. For simplicity sake, we will exclude interest and servicing income from this analysis. If you can generate the $10 million with an internal lending staff, the bank will generally have the $200,000 processing and underwriting expense, and therefore generate $700,000 in profit.

Impact on Stock Price
Let’s say your bank currently makes $1.5 million per year in income from its current activities and has 3 million shares outstanding, or an earnings per share (EPS) of 50 cents. At a typical price/earnings ratio of 10, the bank’s stock should be trading at around $10 per share. If the bank were to create an SBA department and generate the additional $700,000 in pre-tax profits, the after tax affect would be an increase in income of $455,000 or $1.96 million in total profit. This would boost the banks EPS to 65 cents and should move the stock price up to $6.50, which will certainly make your board and shareholders happy.

Other Benefits of SBA Lending
Beyond enhancing profitability and mitigating risk, many banks use SBA lending as a tool to provide better loan structuring for their loan clients. So what are some common ways to utilize the SBA 7(a) guaranty?

Some loans may be better suited to being structured as SBA loans and they may be eligible for refinancing. Converting existing conventional loans or lines of credit by refinancing them into SBA guaranteed loans is one way to improve your portfolio and generate fee income. Banks are allowed to refinance their own debt, but it is important to note that the loan needs to have stayed current within 30 days for the last 36 months. If not, SBA would consider the lender to be putting itself in a preferential position.

We recently had a client refinance a mini-storage loan they had on their books that was coming up for renewal. Their regulator had criticized the bank for having a concentration in mini-storage loans. We completed the refinance of this mini-storage loan for approximately $1.6 million and sold the $1.2 million guaranteed portion for a premium in excess of $133,000.

Many times banks have good clients that need financing for equipment the bank doesn’t feel comfortable relying on as collateral. Some examples of this might be food processing and bottling equipment, car washes, MRI machines or unique manufacturing equipment. However, the SBA guaranty can mitigate the risk of taking unique assets as a form of collateral.

Smaller banks can also use the SBA 7(a) guaranty program as a way to provide funding beyond their legal lending limit. Since the guaranteed portion of an SBA loan is excluded from calculating this limit, it frees up the ability to make more loans to a quality customer.

Conclusion
It is clear that creating an SBA lending group can increase your bank’s profitability and provides some significant advantages. All community banks are looking for new ways to better serve their clients and increase profits. SBA lending provides an opportunity to accomplish both of those objectives and potentially improve the bank’s stock price at the same time.

How Technology Could Improve a Bank’s Audit


technology-6-28-16.png“It’s never simply the hammer that creates a finely crafted home. The result of the work hinges on the skills and experience of the carpenter who wields the tool.

So, too, it’s not so much the powerful cognitive intelligence software, the data and analytics tools, and the data visualization techniques that are beginning to open up opportunities for audit quality and insight enhancements from a financial statement audit. The skills and experiences of the auditors and their firms that implement these technological advancements will make the difference in the months and years ahead.”

When we think of the latest in technological innovations, we inevitably focus on the tools and techniques that benefit consumers. And, while that thinking is understandable, it would be a mistake to believe there are fewer technological advancement opportunities available for banks and other businesses. The litany of technological improvements include major commercial advances in the quality of databases, analytical capabilities and artificial intelligence.

In our world, one of the most compelling possibilities is the use of cognitive technology in the audit of financial statements. Cognitive technology enables greater collaboration between humans and information systems by providing the ability to learn over time and through repetition, to communicate in natural language and analyze massive amounts of data to deliver insights more quickly. Think of the improvements possible in the quality of audits when machine learning can be applied to deliver more actionable insights to guide and focus an auditor’s work or provide feedback on our perceptions of risks to an audit committee and management team at a bank.

While still in their infancy, there is vast potential in developing cognitive intelligence capabilities, especially given the exponential increase in the volume and variety of structured and unstructured data—this is particularly welcome given the ever increasing expectations on auditors, audit committees and management teams.

A prime example of an audit-based application of cognitive technology is the ability to test a bank’s grading or rating control over its loan portfolio. KPMG has developed a bold use case and is building a prototype that will machine “read” a bank’s credit loan files and provide a reasoned judgment on our view of the appropriate loan grade. The KPMG loan grade is compared to the bank grade, with our auditors focused on evaluating the loans with the greatest probability of a difference between the KPMG and bank loan grades.

While still in the development stage, we are encouraged by how cognitive intelligence could be applied to help us improve the quality of our bank audits. Currently, auditors carefully select a sample of loans to test from a bank’s loan portfolio. The sample is selected to provide both coverage of the loan types and grades, as well as where the auditor believes there is the greatest chance of loans being graded incorrectly. Aside from only reviewing a sample of the overall portfolio, today’s audit process is intensely manual. With the prototype being developed, the auditor would be able to select all the loans in a particular portfolio (say, oil and gas) or eventually the complete population of graded loans. The potential benefits to audit quality are very exciting—there is a distinct possibility that every loan in a banks’ portfolio could be reviewed and graded, while bringing outliers to an auditor’s attention. The bulk of the audit effort would then be focused on evaluating these potential outliers.

Further, using the combination of cognitive technologies, data visualization, predictive analytics, and overall digital automation would permit a much more granular evaluation of a bank’s enormous pool of internal and external information. Consider the potential insights that could be extracted when these powerful tools are linked to sources of market indicators. Looking into the future, the possibility exists for building a loan-grading tool to focus on grading commercial mortgage real estate loans tied to a market index of credit-quality values on commercial mortgage bonds, for example.

A tool that reviews changes in the market index against changes in a bank’s portfolio of commercial mortgage real estate loans could both improve audit quality and provide valuable insights into whether the two are consistent. If they are not consistent, those working with this technology—who are freed up from the manual duties–could spend valuable time determining whether or not there is any valid explanation for the inconsistency, better assess the remaining audit risk, and pass along the findings to a bank’s management and audit committee.

And, since such a tool would not be used in a vacuum, each bank’s results and weighted average loan grade could be compared across our portfolio of clients or a select segment of similarly sized institutions.

Even though cognitive intelligence is a powerful tool, it is important to remember that it is just a tool. The real value in cognitive and artificial intelligence is in its ability to allow human beings—in this case bank auditors—the time to think about, and respond to, the results of the testing, then work with audit committees to develop innovative solutions to real-world challenges confronting the industry.

Preparing Your Bank for Sale


bank-sale-2-18-16.pngIf your board is considering a sale of the institution, you’re not ready to sell if you’re not prepared to sell. There are a variety of issues that your board will need to consider if it wants to maximize the value of the bank’s franchise in a sale. Many, although not all of these considerations, involve the bank’s balance sheet. Other important issues include cutting overhead costs and dealing with regulatory compliance issues. Sal Inserra, an Atlanta-based partner for the accounting and consulting firm Crowe Horwath LLP, offered the following advice to Bank Director Editor in Chief Jack Milligan.

Take a hard look at impaired loans on your balance sheet.
When bank executives consider a sale and analyze the loan portfolio, they are not always looking at it from the perspective of a potential buyer. If there’s a problem customer, they have a sense of the potential collection on that impaired loan. When buyers come in cold, they don’t have that history. They are doing an antiseptic review. It is numbers on a page that lead to a conclusion. They’re not going to accept the backstory as a reason why they should pay more for the loan than they think they should. If you have another appraisal in hand that shows the value higher, they may give credence to that, but not as it relates to the sob story. From the buyer’s perspective, if a loan is leveraged with 100 percent loan-to-value with a five-year life, the prospective buyer will require accretion yield of 9 percent to be attractive given the risk. If the coupon on that loan is only 5 percent, the buyer is only going to pay 75 cents on the dollar to achieve their yield. You have to get past the subjective analysis and get more objective detail about that impaired loan. You need to get the most current financial information possible about that impaired loan and the borrower.

Avoid bad leverage transactions as much as possible.
A bad leverage transaction sometimes occurs when the bank has excess deposits and invests in securities of different durations in an attempt to leverage the capital in the financial institution. Depending on how far out into the future the bank is leveraged, it could end up in a bad position where the assets are at a fixed rate, and the liabilities are at a variable rate. And because the bank is maximizing yield, as liabilities start creeping up, net interest margin can erode rather quickly. In the current market, unless the bank wants to go out four or five years or more on a bond and take some credit risk in something other than a U.S. Treasury security, the bank is going to have a pretty narrow net interest margin. Rather than buy low-earning securities, you might benefit your bank’s value by waiting for a buyer with a high loan-to-deposit ratio that needs additional funding. If the seller has excess funding that hasn’t been tied up, that could be a very lucrative purchase to a bank that needs the funding. But once the seller has tied that funding up in something with a narrow net interest margin, the buyer will have to unwind that in order to get value. And if the buyer has to take a hit to unwind that investment, it’s going to impact the seller’s value.

Manage excess capital on the balance sheet.
This is really about how you spin the story of selling the bank. Let’s say you have $50 million in capital. So if you sell for two times book value, you would get $100 million. But of that $50 million, let’s say that $10 million has not been deployed, so you’re not going to get two times $50 million. You’re going to get 1.60 times $50 million, which is $80 million. However, if the bank gets rid of that $10 million in excess capital by paying it out in dividends, it will receive $70 million, but because it is now working off a $40 million base, the bank reports a higher premium. Net cash is still $80 million when you consider the dividend.

Another approach would be to try to leverage up that excess capital. Where you may have turned down a loan before because the pricing wasn’t good, but it was still going to create a good margin and a decent return on investment, the bank may want to invest in the loan because at least it becomes an earning asset. This strategy will depend on what is available in the market.

Shed costly assets or debt before attempting to sell the bank.
Since the value of the bank is based on future earnings, if the bank is carrying some high cost debt, it’s going to impact future margins. Or if the bank has low yielding assets, that’s going to affect future margins. When buyers come in to price those assets and liabilities, they’re going to knock down the value of the bank. Most high cost debt has a prepayment penalty associated with it, so there’s a net cost to get out of that debt. But when it comes to low yielding assets, the bank can maximize net interest margin by getting rid of assets that are going to cause issues for future earnings.

Focus on cost control prior to a sale.
When it comes to cost control, the first thing to look at is the branch network. It’s no secret that branch activity continues to decrease as folks get more and more comfortable with digital banking. I love [author Brett King’s motto], “Banking is no longer somewhere you go, it’s something you do.” And the value of a seller’s branch network may be going down because the cost of maintaining those branches is still significant, not only from a hard cost standpoint but also with training staff, marketing and all the other costs of operating a branch. So take a hard look at those branches that buyers are going to consider exiting. If the bank can start narrowing those costs by closing some of those marginal branches, so that the buyer can see what the run rate is going forward, that will help improve value because the value is going to be driven on the multiple of future earnings.

The other thing I would focus on is staffing. A lot of banks have made big strides in technology, but they haven’t reevaluated their head counts. And they need to do a review of what is necessary to operate and deliver service. A phrase I hear a lot is, “We’re not going to change our head count, we’re going to grow into it.” And that doesn’t necessarily work because as you grow, it doesn’t mean the resources are going to be able to continue to help you get to the next level. So doing a critical analysis of head count is key. Those are the two major variables—branches and people—that when addressed can help you improve your efficiency.

Avoid entering into long-term contracts if you’re considering a sale.
The thing that just makes me scratch my head is when a board is thinking about selling the bank and a year before it pulls the trigger, it enters into a four- or five-year core processing contract. The cost associated with exiting a core processing contract, unless it happens to be the same company that they buyer uses, is incredible. I’ve seen millions of dollars spent to exit a core processing contract.

Factor regulatory compliance issues in a potential sale.
If the bank knows its potential acquirers, it knows its potential new regulators. The key issue is making sure that regulator knows the seller has its compliance house in order. The seller can put together an in-house review or use external resources to address the issues of that potential regulator. If I’m a $2 billion asset bank and it’s likely that I’m going to become part of an institution that’s over $10 billion in assets, I need to be focused on issues that the Consumer Financial Protection Bureau is focused on, because I know that my portfolio is going to be subject to a CFPB review. If I’m a $200 million asset bank and I’m going to merge into bank that’s in the $2 billion to $3 billion range, that may present a higher level of scrutiny. So knowing my potential acquirer allows for adequate preparation.

Community Banks Collaborate on C&I Lending


lending-12-23-15.pngThe traditional community banking model, while still viable, is being challenged because of economic, competitive, technological and regulatory forces—many of which are beyond the control of any individual community bank. The largest banks have used their massive size, product set, and more recently, technology, to make dramatic gains in market share at the expense of community banks. I believe that progressive community banks should be considering new ways of doing business, especially in regards to their lending strategies.

Community banks do many things far better than their larger competitors, while enjoying a degree of trust and resiliency that the megabanks may never achieve. But those big banks boast something the community banks, standing alone, cannot match: the scale to operate the lending platforms which are now necessary in most lines of business—including commercial & industrial (C&I) lending. Many American businesses now require loan amounts of $50 million or more, a loan size that typically defines the low end of the “middle market.” Those loans required by middle market borrowers, companies providing goods and services serving a wide range of industries, far exceed the individual lending capacity of the typical community bank. The teams required to source, screen, underwrite and manage these larger loans are typically out of reach for a community bank.

To date, those megabank advantages have clearly outweighed the strengths of community banking in C&I lending. Without the ability to deliver many of the commercial loans that middle market businesses require, community banks are stuck in a quandary in which they often have to turn away customers with successful, growing businesses. The numbers are clear: In 1990, community banks with under $10 billion in assets accounted for over one-third of C&I loans held on the balance sheets of banks. By the end of 2014, community banks’ share of the C&I market has dropped to just over 15 percent of the market. The continuation of this trend will likely limit the profitability and growth of community banks as well as their ability to positively affect their communities in other lines of business. Equally important, it also subjects those banks to less diversified loan portfolios and the risk associated with loan concentrations, particularly in commercial real estate.

While each community bank may individually struggle to match the scale of the mega-banks, it is important to keep in mind that the biggest banks are saddled with their own challenges such as bureaucracy, legacy systems, resistance to change, customer fatigue and burdensome regulatory oversight.

Community banks, but for their individual lack of scale, ought to be well positioned to capitalize on these opportunities and to outcompete the megabanks. The innovation required for community banks to break this logjam—to free them to focus on their strengths—is here, and its essence is this: community banks no longer need to stand alone.

They can prosper by working together, particularly in gaining access to middle market lending. Community banks do have the scale enjoyed by the biggest banks, they just don’t have it on their own. Together, community banks hold $2.3 trillion in assets—13 percent of the assets held by US banks, and just shy of the assets of JPMorgan Chase & Co., the largest US bank. The question is how to leverage that scale while preserving the individuality, proximity to the customer and legendary service that contribute to their unique value.

Community banks should consider joining together in alliances or cooperatives in order to gain access to C&I loans, including diversified sectors such as manufacturing, healthcare, technology, and business services. In addition to using such partnerships to successfully source these loans on a national basis, other benefits such as diversification (size, geography, and industry type), access to larger customers, and combined expertise in underwriting and loan management can be achieved. One such cooperative, BancAlliance, consists of over 200 community bank members and has sourced over $2 billion in such loans.

Through partnerships such as these, community banks can succeed in delivering loans to job-creating middle market businesses throughout our country at a reasonable cost to each community bank, while adding to their net interest margin and diversifying their balance sheet.

How CRE Lending Has Evolved


growth-strategies-9-17-15.pngFor 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 mking@bankdirector.com. We also encourage you to comment below if you would like to share how your bank’s CRE lending strategy has evolved.

Case Study: Growth through Niche Lending


Despite a fiercely competitive marketplace and continued fallout from the latest recession, banks that are willing to make the resource commitment can generate loan growth through specialized lending programs. In this video, Steve Kent of River Branch Capital LLC, shares how his client, QCR Holdings Inc., developed a scalable and profitable loan portfolio of niche businesses.


Growing Your Loan Portfolio



As banks look to fuel their loan growth in this highly challenging market, many are trying to diversify away from a heavy commercial real estate portfolio by looking to other profitable business lines. However, growing the loan portfolio has proven difficult and this session, filmed during Bank Director’s 2014 Growth Conference, shows approaches banks are taking.

Video Length: 45 minutes

About the Speakers

Douglas H. BowersPresident & CEO, Square 1 Bank
Doug Bowers is president and CEO of Square 1 Financial and Square 1 Bank. He has over 30 years of banking experience from Bank of America and its predecessors, where he held a wide range of leadership positions, including head of commercial banking, head of foreign exchange, head of large corporate banking, president of EMEA (Europe, Middle East and Africa) and president of Bank of America’s leasing business.

Wayne Gore, Senior Vice President, BancAlliance
Wayne Gore is a senior vice president of Alliance Partners and has been with the group since its formation. Prior to joining Alliance Partners, Mr. Gore held leadership roles in the financial institutions group with McKinsey & Co. and served as managing director at the corporate executive board. Previously, Mr. Gore was an investment banker with Merrill Lynch and Goldman Sachs as a member of the mergers & acquisitions teams.

Jim Mitchell, President & CEO, Puget Sound Bank
Jim Mitchell is president & CEO for Puget Sound Bank. After spending over 30 years in executive banking roles in the Seattle area, he assembled the team that started Puget Sound Bank. Past local positions include senior vice president and manager of the Seattle corporate banking office of Sterling Savings Bank and senior vice president of U.S. Bank in Seattle.

George Teplica, Senior Vice President and Director of Commercial Banking, The Bryn Mawr Trust Company
George Teplica is the senior vice president and director of commercial banking at The Bryn Mawr Trust Company. He leads Bryn Mawr Trust’s Commercial Banking Group, which delivers credit and other financial services to closely-held businesses, professional firms and not-for-profit organizations in metropolitan Philadelphia.

How to Handle Loan Portfolio Valuation and Avoid Trouble Later


12-23-13-Crowe.pngIn most acquisitions, the selling bank’s loan portfolio generally is the largest asset. Valuing it often consumes the majority of the valuation team’s effort. Achieving consensus on fair value can be challenging, as there typically isn’t an observable market price for most bank loan portfolios. In fact, the acquirers’ management often is surprised by the difference between its pro forma balance sheet projections and the final independent, third-party valuations. These unexpected changes in valuation could have a significant impact on the acquiring institution’s regulatory capital requirements and future earnings potential.

In most acquisitions, the valuation of the loan portfolio primarily is performed using a discounted cash flow method and various assumptions such as probability of default, loss given default, prepayment speeds, and required market rates of return on the projected loan cash flows.

What should management teams think about as they approach acquisitions and determine pricing and purchase price allocations? Here are a few considerations:

  1. To achieve a result that can be managed on an ongoing basis, loan valuations require a balance between the acquiring bank’s various internal management teams. For example, in many cases, finance teams significantly rely on the credit review due diligence team to assign the fair value marks on the loan portfolio. Note that the credit review team must provide its input for the results to be consistent with how the credits will be managed post-acquisition. An issue sometimes arises because most credit review teams typically provide identified loss ranges that are more applicable to an allowance for loan loss method. Alternatively, consider a range of life-to-date loss projections that can be presented to the board and management as best-case/worst-case scenarios to evaluate the overall merits of the transaction.
  2. The absolute credit mark might be fine for due diligence, but to be in compliance with U.S. generally accepted accounting principles (GAAP) and Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, “Business Combinations,” the timing and amount of expected loan cash flows need to be projected, and the market-required rates of return on the cash flows must be considered. Both the credit review and finance teams need to keep this distinction in mind, because incorporating both the timing and amount of loan cash flows and market-required returns often will decrease the values from the basic credit marks.

    Consider market factors other than credit, timing, and market pricing in the analysis. ASC 805 and the fair value standard ASC 820, “Fair Value Measurement,” require acquirers to value loans using an “exit pricing” method, which loosely translates to what a willing buyer would pay a willing seller for that loan. This differs from other methods such as asset/liability fair values that often use a bank’s own new loan rates as the basis for discounting the cash flows. Under GAAP, using the current interest rate for the institution to make a loan is labeled as an entrance price, while acquisition accounting GAAP requires an exit price, or the price to sell the asset or assume the liability.

  3. One of the primary market factors to consider in addition to the basic valuation inputs (such as discount rate, credit loss factors, prepayments and the contractual loan principal and interest payments) is the liquidity discount applied to each loan. It takes time and effort to sell a loan or a loan portfolio, and that time affects pricing. The more difficult a loan portfolio is to sell, the higher the liquidity discount that is factored into the required rate of return. Additionally, market perception is a factor that affects pricing no matter the credit quality. For example, loan portfolios with heavy concentrations of home equity or construction loans are discounted regardless of credit quality because of the market’s negative perception of this lending type.
  4. Plan for the post-acquisition accounting processes in advance of due diligence and deal completion. Accounting for loans in an acquisition after the deal is closed is complicated and requires systems, processes and coordination with the various teams within the bank. For credit impaired loans, the teams working on those loans must provide feedback to the accounting team on the timing of cash flows and the ultimate values that might be realized for each loan.

Because loan valuations are complex, it is crucial that banks coordinate between their internal teams and external resources. Proper planning and process development can result in due diligence expectations that are consistent with post-completion valuations.

Specialized Lending Programs: What Boards Should Know Before Getting Started


In response to increased regulatory pressures and a sharp economic downturn, many banks are looking at alternative lending categories to grow their loan portfolios. In this video, Steve Kent of River Branch Capital, shares what banks should consider before embracing specialized lending practices such as government guaranteed lending, asset based lending and multi-family housing lending programs.