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BirdsEye View

commercial banking - it's time to get back to business
Commercial banking  executives around the country have been licking their wounds. Workouts and distressed borrowers have occupied many a lender,  and some lending lines, such as commercial real estate or Acquisition, Development and Construction loans, have ground to a halt in most markets.
 
What are commercial bankers thinking of as 2010 unfolds?   Here's what I'm thinking. 
 
ABOUT THE RECENT PAST AND ITS VESTIGES
 
We have too many bankers who have not been through the hard times. Commercial Banking executives realize that too many of their cadre of relationship managers have never been through a downturn. Arguably, none of us have been through the downturn we’ve experienced in the past two years. At the same time, bankers who bear the scars from the ‘80s, especially Texas bankers, have generally handled the downturn more effectively. RMs need to develop a healthy sense of cynicism, and to realize that even their best customers may be driven to desperate acts during these desperate times.
 
Lesson from this debacle: The moral collapse. This cycle has shown us behavior we have not seen before. Borrowers who can pay the loan choose not to do so. They walk away from their houses and other obligations. Their debt hierarchy has changed dramatically, with credit cards and auto loans taking precedence over house payments. And, on the purely commercial side, fraud is rampant. Even the best of customers can commit previously unthinkable acts, and they are more likely to do so today than ever before.
 
Focus on leading indicators for trouble. Borrower distress doesn’t happen overnight, yet we miss it all too often. Identify solid leading indicators to yield early warnings as borrowers’ situation deteriorates. For example, a decline in average collected DDA balances is not a good thing, and is often a harbinger of worse things to come. Similar indicators include large overdrafts or large uncollected balances.
 
Investors are coming in from the sidelines. Pricing for improved land (a.k.a. PVC farms) and other distressed loan types has improved in many markets, with discounts receding to 30-50%. In some cases buyers are rezoning yet again the land back into agricultural use – how ironic. Buyers’ interests are not consistent throughout the country, with the exception of unimproved land, which has few buyers, if any.
 
What will happen when the 5 year balloons come due? Many bankers are concerned about the impact on real estate values when loans made 3-4 years ago come due. As the shadow banking system melted away altogether, some borrowers will find themselves unable to refinance or obtain a permanent takeout, which might result in a major hit to prices as properties enter foreclosure.
 
Deciding which borrowers are survivors has become an important skill. Some distressed borrowers can survive, possibly with scaled down operations. Others are on life support and could not survive long term. Determining which is which and how to handle both groups is a central activity to commercial bankers and workout specialists alike. Some banks, especially community banks, are willing to work with those they expect to survive. At the same time, taking a loss and selling “living dead” loans seems to be a common strategy, as executives struggle to shed the distractions and expense of workout properties.
 
Commercial restructuring committee – an idea whose time has come. Those community banks who are committed to cleaning up the mess and avoid self-delusion at all costs have formed commercial loan restructuring committees, comprised of senior executives. The committee meets to take a frequent and hard look at the portfolio and determine what to jettison and what to keep. Public companies’ stock prices generally reacted favorably to distressed asset sales, even when they burn through newly acquired capital, as they view these sales as the first step to recovery.
 
Real estate value are unlikely to reach previous highs. The realization that the peak values we saw are unlikely to return during the planning horizon has set in, which reinforces banks’ willingness to take a realistic look at their loan portfolios.
 
ABOUT THE FUTURE AND ITS OPPORTUNITIES
 
Memories are short. We are already seeing price and term deterioration in some markets, especially where large banks have made the decision to return to the playing field. Resisting the temptation to follow suit, especially as your RMs tell you the pricing model is not competitive, will be difficult. The price deterioration and your standing steadfast against it can cause a morale problem among your RM ranks, so be prepared.
 
Less participations, more core loans. Another lesson from the past few years has been the realization of how little control participants have over a loan participation that goes bad. Further, it became clear to many that their interests and those of the syndicators are not in sync, and often are in conflict. While some banks have developed strong expertise in buying participations, most others have used these as “fillers” to the loan portfolio, and consequently suffered meaningful losses during this period. The lessons: First, participations have less franchise value and more risk than core relationships (although they are often less expensive to originate). Second, know your syndicator. Club deals of banks with like-minded credit culture are the way to go.
 
More prospects are willing to listen than ever. Typically, about a third of bank commercial customers are willing to listen to another bank’s pitch at any given time. Today that number has doubled, as per Greenwich Research. Some customers don’t even give their bank the right of last look; they instead opt for something they consider new and fresh. What an amazing opportunity for commercial bankers who are not too buried in workout mode.
 
Prioritize prospects quarterly. Prospecting is a difficult job, and the sale cycle is very long. Be frugal with your bankers’ time by ensuring they go after the prospects the bank is interested in. Pre-approve or at least have prospects pass the ”laugh test” before your bankers start the 7+ appointment cycle it usually takes to acquire a new customer.
 
 Identify your core and best (high potential) clients. Segmenting your customer base, which typically accounts for 70% of all sales, is a profitable activity. The key is the definition of what makes a good client. There are many ways to approach this, and the activity itself is often quite revealing. 
 
Set firm cross-sell expectations. As RMs redirect their attention to acquiring new relationships, which, as mentioned above, is a significant and timely opportunity, learn from successful banks who goaled, priced and achieved deeper and multiple relationships with prospects. Doing so not only increased the customer profitability, but also their longevity with the bank.
 
Another solid method to improve cross selling is to embed a Treasury management sales person in every commercial banking team, as well as cross-goal and cross-incentivize them.
 
Be selective. Not all prospects are worthy of receiving your precious capital. In addition to the usual analyses, banks found that conducting a full background check on prospective clients proved useful and helped many sidestep numerous landmines. Incorporate the permission to conduct such a search into your loan documents. Typical fee for this service is $100 per prospect, and the money is very well spent.
 
Improve your loan monitoring. Annual credit review are no longer frequent enough. Today’s best practice involved creating a one page form that outlines the relationship’s major features, such as company’s balance sheet, profitability, covenant performance, critical issues. This single pager can be the basis for quarterly discussions with the commercial executive team to revisit collateral advance rates, borrower performance relative to their industry and projections, etc. Such reviews also facilitate a more realistic credit rating, which, too often, doesn’t change after the loan has been made.
 
Establish a fulfillment team for new customers’ deposit accounts, ACH etc. The paperwork can be overwhelming and a barrier to completion. Appoint a few individuals who can assist both prospects and existing customers in completing the necessary documentation for various bank products.
 
Convert some lenders into deposit gatherers and hand holders. Too few commercial and small business depositors get attention. RMs more often than not hunt for loans, not deposits, and the larger the better. Some of your RMs would feel comfortable focusing on deposit-only (or mostly) customers and prospects, Customers deeply appreciate the attention, and your core deposit numbers will attest to that.
 
Now is the time to mobilize your RM for the battle for the next stage of snagging market share from your competitors. Weak banks’ customers are looking for a new home, as are many commercial clients who have been “fired” from their larger (but risk-based capital starved) banks.
 
The past two years have been unique in a negative way. The opportunities they yield are unique in a very positive fashion. Like Elvis said (well, almost), “It’s now or never!”