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

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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.

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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:

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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

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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

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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

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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.”

Cash for Truckers Turns Into Cash for Bankers

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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

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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

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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

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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.