The Trouble That Johnny Allison Sees

Johnny Allison, chairman and chief executive officer at Home Bancshares in Conway, Arkansas, prides himself on running a very conservative institution with a strong credit culture. And Allison has not liked some of the behavior he has witnessed in other bankers, who are slashing their loan rates and loosening terms and conditions to win business in a highly competitive commercial loan market.

Allison says those chickens will come home to roost when the market eventually turns, and many of those underpriced and poorly structured loans go bad.

“Now is a dangerous time to be in banking, in my opinion. It is a scary time because our people want to match what somebody else did,” said Allison during an extensive interview with Bank Director Editor in Chief Jack Milligan for a profile in the 1st quarter issue of Bank Director magazine. (You can read the story, “Will Opportunity Strike Again for Johnny Allison?” by clicking here.)

Allison feels strongly enough about the credit quality at $15 billion asset Home that he’s willing to sacrifice loan growth, even if it hurts his stock price. In the following excerpt, Allison — whose blunt and colorful talk has become his trademark — opens up about the challenge of maintaining underwriting discipline in a highly competitive market.

The Q&A has been edited for brevity, clarity and flow.

BD: You said some very powerful things in your third quarter earnings call. And you said it in sort of the Johnny Allison way, which makes it fun and entertaining. But you were fairly blunt about the fact that you see stupid people doing stupid things. That has to have an impact on your performance in 2019. You’re letting certain kinds of loans run off because you don’t like the terms and conditions and the pricing. That impacts your growth, which then impacts your stock price. That has to be a difficult choice to make.
JA: It’s extremely tough, because my people in the field are seeing dumb stuff being done. “Well, so and so did this, or so and so did that, and, Johnny, they gave him three-and-a-half fixed for 10 [years], and interest only, and nonrecourse.” I mean, there will be a day of reckoning on those kinds of bad decisions, in my opinion. Am I going to write at three and a quarter [percent] fixed for 10 to 15 years? I’m not going to do that. Do I not think I’ll have a better opportunity coming next year to where I haven’t spent that money, and I spend it next year? So, my attitude is [to] take what they give us. Stay close to your customers, support your customers. It is extremely tough. It is one tough job keeping the company disciplined. Don’t let it get off the tracks. We’re known as a company that runs a good net interest margin. We’re known as a company that has good asset quality, that runs a good ship.

BD: If you were more aggressive on loan growth, if you were willing to play the same game that other banks were playing and not worry about the future so much, would your stock price be higher today?
JA: We don’t believe that. If I loan you $100 and I charge you 6%, or I loan you $100 and I charge you 3%, you’ve got to do twice as many loans just to keep up with me. And there’s a limit to how much you can loan, right? We got $11 billion worth of loans. We’re about 97% loan-to-deposit [ratio]. Could we go up to 100%? Sure. We were at [100%] over six years ago. The examiners fuss at you a little bit. But we’ve got lots of capital. So, we kind of run in those areas close to 100% loan to deposit. But we’ve got $2.7 billion worth of capital, so we can rely on that. Plus, the company makes a lot of money.

BD: You said in the earnings call that you were building up the bank’s capital because you didn’t quite know where the world was going, or you weren’t quite certain about the future. So, how do you see the future?
JA: I’m very positive with the future, except the fact I keep hearing these naysayers on and on. We’re optimistic people. I’m rocking with the profitability of this company, and [people] tell me the world’s coming to an end. Then the [bank’s] examiner came in during [the] third quarter and said, “The world’s coming to an end, Johnny. Get ready. Be prepared. Get your reserves [up].” We didn’t ever see it. It didn’t happen. Could somebody be right? Could there be a hiccup coming? Let me say this, and I said it on the call, banks are in the best financial condition that they’ve ever been in.

Someone said, “Boy, you give the regulators credit for that.” I said, “Regulators had nothing to do with it. Absolutely nothing to do with it.” What did it was [the financial crisis in] ’08, ’09, and those people who wanted to survive, and those people who wanted to keep their companies and don’t want to cycle through that again. What’s happening is, the shadow banking system is coming into the [market], and they’re taking our loans. How many [loan] funds are out there? They all think they’re lenders. Every one of them think they’re lenders. And they’re coming into the bank space. Where we’re at 57% loan to value, they’re going to 95% loan to value.

There’s the next blow up, and that’ll hurt us. We’re going to get splashed with it. We’re not going to get all the paint, but we’re going to get splashed with that.

That’s the next problem coming, these shadow bankers, the people chasing yield. REITs. Oh, God. REITs. I’m in at $150,000 a key in Key West, Florida, with a guest house owner who is a fabulous operator. We financed her for years and years, and she’s built this great program with these guest houses. She sold it to an REIT for $500,000 a key. Now, let me tell you something, you can’t have an airplane late getting into Key West. There can never be a wreck on [U.S. Highway 1]. And there can never be another hurricane. Everything has to be hitting on all cylinders and be perfect to make that work. That’s kind of scary to me. We’ve seen several of these REITs coming [in with] so much money. They won’t give any money back to the investors. They won’t say, “We failed.” Instead, they’ll go invest that money. And they’re just stretching that damn rubber band as far as they can stretch it, and I think some of those rubber bands are going to pop.

[Editor’s note: An REIT, or real estate investment trust, owns and often operates income-generating real estate.]

So, I think that’s the danger. I don’t think it’s the normal course of business. I think those things are the danger. And when it slows down a little bit like it did, these bankers panic. They just panic. “What can we do to keep your business? What can we do?” They just lay down and play dead. “What can I do? What can I do? Two and a half? Okay, okay, okay. We’ll do [loans at] two and a half [percent].” We just got back from a conference, and they’re talking in the twos. Bankers are talking in the twos. I don’t even know what a three looks like, and I sure don’t know what a two looks like. So, I can’t imagine that kind of stupidity.

BD: So, where are we in the credit cycle?
JA: Well, two schools of thought. One, that we’re in a ten-year cycle, and it’s time for a downturn.

BD: Just because it’s time.
JA: Just because it’s time. Johnny’s thought is that we were in an eight-year cycle with [President Barack] Obama, and he didn’t do one thing to help business. Absolutely zero things to help any kind of business at all. Didn’t know what he was doing. Nice guy. Be a great guy to drink beer with. Had no clue. And then here comes [President Donald] Trump. So, did the cycle die with Obama and start with Trump? That’s my theory. My theory is that [the Obama] cycle died, and we’re in the Trump cycle. Now, if we have a downturn, if something happens somewhere, he’s going to do everything he can to get reelected, right? So, he’s going to try to keep this economy rolling. But if we have a downturn, it’s not going to be anything like ’08, ’09.

The regulators blame construction for the [financial crisis]. It wasn’t construction that caused the crash. It was the lenders and the developers that caused the crash, because nobody put any money in a deal. Nobody had any equity in a deal. I remember many times, my CEO, I’d say, “See if you can get us 10%.” No. [The customer] got it done for 100% financing. If you want the deal, they give it to you. But it’s 100% financing. There wasn’t any money in the deal. There was no money in those deals, and when the music stopped, they just pitched the keys to the bankers, and here went the liquidation process. I was involved in it, too. I did some of it myself. So, I’m not the brilliant banker that skated that. I was involved in it. Not proud of that, but I learned from that lesson. I learned from that lesson.

Now is a dangerous time to be in banking, in my opinion. It is a scary time, because our people want to match what somebody else did. That’s my toughest job. And a lot of them think I’m an ass because I hold so tight to that. Now, let me tell you. This is my largest asset. This is my baby in lots of respects. I have lots of my employees that are vested in this company. I have lots of shareholders, local Arkansas shareholders that are vested. We have created more millionaires in Arkansas than J.B. Hunt [Transport Services], or Walmart, or Tyson Foods. Individual millionaires, because they believed in us and invested with us, and I am very proud of that.

A Community Bank’s Pursuit of Coast-to-Coast SBA Lending


lending-7-11-18.pngTraditional processes for underwriting and originating small business loans can be expensive and onerous for the typical financial institution, making it difficult to make these loans profitable. But Stuart, Florida-based Seacoast National Bank—through its partnership with SmartBiz, based in San Francisco—is already experiencing significant growth in SBA loan volume by automating the process and accessing a nationwide pool of prospective customers. In fact, the $5.9 billion asset bank plans to crack the Small Business Administration’s list of the top 100 SBA lenders by the end of this year.

It’s hard to argue with the results so far: Data from the SBA reveals the bank’s average number of loan approvals for 2018—43 per quarter as of June 22—are almost equal to the total number of SBA loans the bank approved (46) in all of 2017. Of the 129 SBA loans approved by Seacoast so far this year, almost 100 were generated through SmartBiz, according to the bank. SBA loan volume is at $33.9 million so far for the year—more than double the amount approved by the bank last year.

Seacoast started working with SmartBiz about a year ago, due to its interest in the fintech firm’s ability to provide access to a broad, national base of potential customers, says Julie Kleffel, executive vice president and community banking executive at Seacoast.

Eight banks currently participate in SmartBiz’s loan marketplace. Each bank outlines its credit policies and desired customer criteria with SmartBiz, which allows it to serve as a matchmaker of sorts between customer and lender. “We’re able to send the right borrowers to the right bank,” says SmartBiz CEO Evan Singer. Roughly 90 percent of the customers matched to the company’s partner banks are ultimately approved and funded, which benefits both the customer and the bank, which is less likely to waste time and resources underwriting a loan that it ultimately won’t approve.

Seacoast’s underwriters have the final say on whether the loan is approved, and they close the loan, says Kleffel. The guaranteed portion of the loan is sold on the secondary market, with Seacoast keeping the unguaranteed portion. (Under the SBA 7(a) loan program, the SBA pays off the federally guaranteed portion if the loan defaults.)

Kleffel says the two entities have a “collaborative” relationship and spent time early on learning how the other does business. Together, “we provided a way to better serve both our existing clients as well as new clients [SmartBiz is] introducing us to,” she says.

Seacoast currently ranks 108th on the SBA’s list of top lenders, putting the top 100 within sight. Access to more customers through SmartBiz has contributed to the bank’s SBA loan growth, but a more efficient process means the bank can handle the increased volume. The traditional 30- to 45-day process has been cut to 11 or 12 days, according to Kleffel. Ultimately, the bank would like to approve SBA loans within 10 days of submission.

Singer credits Seacoast for making the most of the partnership. “The leadership at the bank has really embraced innovation, and you can see what they’re doing out in the marketplace to meet customer needs,” he says, adding that the experienced SBA team the bank has in place is another key differentiator.

Seacoast aims to treat these new customers just as well as the customers it would attract more traditionally through its Florida branches. Each new customer receives a call from a Seacoast banker, introducing them to the bank. The same banker “works directly with them all the way through closing and post-closing, so that they’re appropriately brought into the Seacoast family with the same level of care” as any other customer, says Kleffel, with an eye to retaining and growing the relationship.

Seacoast has accomplished this growth without hiring new staff. SBA loan origination is currently supported by just five employees, including a department manager. Supporting that level of loan volume and growth would require double that without SmartBiz on board. The partnership, Kleffel says, “has allowed us to pull through more revenue, faster, with [fewer] people and a better customer experience.”

Eating Soup with a Fork: Why Banks Struggle with Small Business Lending, and How to Fix It


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For most regional and community banks, the old-fashioned business of making loans remains their most important source of revenue. And for most of these banks, small businesses are a big part of their customer base. Yet they struggle to lend to small businesses profitably.

You’ve probably heard the statistics before: Small businesses represent about half of all U.S. employment and about 40 percent of private sector GDP, according to the U.S. Small Business Administration, and yet they only get around 21 percent of commercial bank credit. Nearly half of all small businesses sought some kind of loan in 2015, according to the Federal Reserve Bank of New York (the last year for which we have broad data from Fed surveys), so the demand is there. What’s going on here?

As anyone who is familiar with lending to small business can tell you, it has traditionally been extremely difficult to measure and manage small business credit risk in a cost-effective way. Current legacy methods either expose the bank to too much risk or incur so much cost that small business loans can’t be made profitably. Hence, banks are unwilling to deploy capital to small businesses on the same scale they do to consumers or large commercial entities.

The False Dichotomy of “Consumer” and “Commercial”
The difficulty that banks experience trying to make loans to small businesses is like trying to eat soup with a fork.

Let me explain.

When it comes to lending, most banks still see the world falling into one of two categories: “consumer” or “commercial.” Consumer lending is a highly-standardized process while commercial is a highly bespoke one.

The consumer process gains its efficiency by ignoring the positive attributes every small business has, such as cash flow, and primarily relies on the small business owner’s credit score to assess risk. This generally means that the lender is not getting an accurate read on capacity and risk, and therefore is very likely to either take too much risk or turn away a lot of potentially good business.

The commercial process, on the other hand, gains its reliability by taking a far more diligent approach. It requires a heavy dose of manual credit analysis done by highly trained (and well compensated) professionals. Lenders expend significant time and resources gathering information, spreading financials, reviewing collateral and analyzing many aspects of each business to a degree that a small request—say for $25,000—is treated much the same way as a larger $750,000 request.

The Right Tools for the Job
Small businesses are a different category of customer. Most have a mix of consumer and commercial attributes. To underwrite them effectively and profitably requires marrying some of the efficiency of the consumer process with some of the underwriting capabilities of the commercial process. Either one alone will fail.

If your only choice is a fork when eating soup, the experience is going to be so frustrating you’ll likely give up.

But what if you had a spoon?

Here’s what a small-business-lending spoon looks like:

First, it enables online originations to reduce the dependency on expensive bankers for small loan requests.

Second, it provides the flexibility to use better small business underwriting information such as real time operating cash flow versus dated tax statements or just the owner’s credit score. For example, reviewing the past 60-90 days of bank transactions is more indicative of the credit worthiness of a restaurant than the information in a dated document or a lagged credit bureau score.

Third, it supports automation to manage every step of the application process as well as the subsequent servicing and monitoring of the loan. As an example, bankers today will process loans sequentially without regard for incoming credit quality or loan size. How much more efficient would it be if loan requests where categorized into “likely approval,” “likely decline” and “needs review” before a banker received them? The power of a speedy decline would eliminate a significant amount of wasted time and effort.

As a former banker and experienced tech entrepreneur, I have been fortunate enough to witness and even play a role in forging some of the early “spoons” that have helped transform this market. So far, however, most of the pioneering work here has happened outside banks.

What Bank Can Do
Small business lending will not be solved by building more branches, or spending more money on training and marketing. Banks must expand their technology tool set, especially when originating small business loans.

So how does a bank introduce new technology without it costing millions of dollars and years of effort?

A bank must look to the new breed of bank-friendly technology companies for help. Many of these new fintech companies can make the process of testing and adopting new technologies remarkably easy and cost effective. Long gone are the days of long-term contracts, expensive integrations and multiyear implementations. The ability to quickly test technology and pay for rapid success is here. Banks just need to find the right partner and have the willingness to explore the possibilities.

If you are hungry for some soup and want to enjoy it, go get yourself a spoon. Stop the insanity. There are better ways to manage small business lending in a cost-effective manner, it is time to look beyond your legacy technology providers for a solution.

Small Business Lending: Partnering Your Way to the Top


small-business-loans-4-25-16.pngSmall business (SB) lending is a large and yet still underserved market in which community banks are generally well positioned to compete. The SB commercial loan market represents approximately $1 trillion in outstanding loans, of which banks hold over $500 billion. Approximately one-third of these assets are currently held by community banks. Despite those impressive figures, the existing small business market is smaller than it could be as large numbers of creditworthy small businesses needing smaller loans are not able to access the credit for which they likely could qualify, largely due to the costs of accessing and underwriting those loans.

Critically, it is the smaller SB loans—i.e. those below $250,000—that constitute the majority of the potential market of borrowers: a recent Federal Reserve survey suggests that applicants seeking less than $250,000 represent approximately 70 percent of total small business applicants. But most banks struggle to make such loans profitable, due to the fixed costs of traditional underwriting and processing relative to the smaller revenue opportunities.

On the other side of the equation, the lending market is undergoing a transformation driven by technology and new competition that is rapidly increasing the investment and scale necessary to compete. This technology is designed to reduce underwriting costs, shorten approval timelines and provide a more user-friendly customer experience. Larger banks and new, nonbank lenders are aggressively using this technology to expand share in SB lending, especially in the underserved smaller balance loan space that is so important to community banks.

Community banks are already gradually ceding SB market share—first to the larger banks and more recently to new technology-enabled nonbank lenders, commonly referred to as fintech lenders. Unfortunately, each community bank alone typically lacks the individual scale required to invest in technology that is now required to compete.

Banks, and particularly the largest banks, appropriately see the emergence of fintech lenders as a potential threat. But, since many community banks lack the resources to build or buy a technology platform on their own, the emergence of fintech lenders who can partner with community banks provides a new and attractive option for community banks to serve these important SB customers and to gain market share.

Federal Reserve Governor Lael Brainard summed up the opportunity for community banks as follows:

“Some view the growth of online platforms as a challenge to community banks in their traditional core businesses. But it is also possible that the very different strengths of community banks and online lenders could lead to complementarity and collaboration in the provision of credit to small business….”
… By working together, lenders, borrowers, and regulators can help support an outcome whereby credit channels are strengthened and possible risks are being proactively managed.”

Fintech partnerships designed to empower community banks should demonstrate the following characteristics:

  • Enable banks to offer a product that is otherwise not widely available through that bank and/or to replace a costlier or inefficient product with a better solution;
  • Enable banks to provide a “yes” to more of their customers, facilitating access to credit even if the customer is not yet able to meet bank credit standards;
  • Ensure banks retain control of the customer relationship and the customer’s experience;
  • Increase fee income and earning assets; and
  • Ensure banks are able to meet regulatory expectations and best practices.

In its January 2015 paper on collaboration by community banks, the Office of the Comptroller of the Currency (OCC) states: “As a group of like-minded institutions, community banks may find the benefits of collaboration outweigh competitive challenges and could strengthen the future viability of community banks. The OCC supports community banks in exploring opportunities to achieve economies of scale and the other potential benefits of collaboration.” The OCC goes on to note that community banks that collaborate must manage the risks inherent in such a collaborative arrangement but states “there are risks to collaborative relationships, but there are also risks to doing something alone without the proper expertise or in an inefficient or ineffective manner.”

I couldn’t say it any better. In connection with SB lending, therefore, community banks should assess the extent to which a collaborative approach may offer benefits of collective scale, expertise and efficiency in a controlled and compliant manner. They may just find that the benefits readily outweigh the risks, and that fintech offers a powerful opportunity for community banks to regain share in a number of product lines that have come to be dominated by the largest banks.

Protecting Your Home Equity Portfolio


1-7-15-Sutherland.pngHome equity loans are back in vogue. Property values have increased. Mortgage rates have inched up.  Borrowers are seeing the home equity product once again as a viable option.

But let’s not forget the past. With the dramatic decrease in property values coupled with loose underwriting standards of the early 2000s, home equity portfolios met an ugly moment. These loans continue to place a strain on servicing operations. Home equity loans originated 10 years ago are undergoing rate adjustments and requiring re-payment. The potential for payment shock and default are real.

Home equity portfolios have become a focus of the Federal Deposit Insurance Corp (FDIC). At the beginning of the year, the FDIC released a bulletin addressed to borrowers alerting them to potential pitfalls of their home equity loan, particularly if it was due for an interest and payment adjustment as it came to the end of its draw period. They advised the borrower to contact their lender to explore refinancing or seek a loan modification. Further, in a bulletin to the banks, the FDIC cautioned them to take steps to review their home equity portfolio, identify loans or borrowers that may have trouble and to take proactive measures to avert problems before they arise.

Now is the time to review your servicing operations to determine whether you are meeting the needs of your current home equity customer base while ensuring that you meet the requirements of your new customers. How is your servicing set up? Are you relying on the first mortgagee to protect your interests through the escrowed payment of taxes and hazard insurance? It is extremely doubtful that they serviced their first mortgage loans with your interests at heart. Thus, how are you tracking these important items which can cause serious problems if left unchecked?

It is important that you address the special needs of the home equity portfolio and borrower.

  • Does your current home equity servicing system have the capability to monitor the mortgage aspects of the loan? Can it provide escrow tracking routines, and even collect escrow if required?
  • Have you established an on-going risk model of the portfolio using current loan level data as well as borrower and property information which will allow you to identify potential risks before they arise?
  • Do you have a single point of contact strategy in place in the event of default or loan modification needs? Do you have loan modification models and options planned that will meet borrower needs?
  • Do your underwriting criteria need to be changed to meet today’s environment?
  • Do your closing requirements need to be amended to ensure that you are properly secured?

This is an excellent opportunity to examine your operations.  Department expansion to meet increased loan requests on the front end and address expanding servicing requirements on the back end can be expensive. Take the time to review your internal policies and processes. Explore how outside resources can improve your delivery and enhance your bottom line. Any or all of these functions can be outsourced to a company that will partner with you to meet department and corporate objectives.

Home equity lending is back. It is important not to repeat the errors of the past but to create operations that best support the needs of the borrower and meet the requirements of the bank.