Chief Investment Officer
Commercial Loan Automation
small business banking
So many banks are flocking to the small business space, yet the definition of what small business is, and the approaches to tackling the segment, are numerous and inconsistent.
Our small business forum helped identify some of the best practices in approaching this business. Several are shared below. For the remaining great ideas, come to our next Business Banking Forum, April 19-20, 2012, Boston, MA.
- Qualifications for an effective branch manager to manage small business in their area: They should be charming; pay close attention to retail; have a good understanding of a more complex deposit product line; and be able to use credit scoring model.
- Use of middle office/back office is key to success. Efficiency is a critical success factor to small business banking. You can't process and underwrite them the same way you do a $2 million loan; the cost is simply too high. Creating a streamlined yet effective process and populating the back office with competent people is always important, but in this line of business it's truly essential.
- 2:1 deposit source. Expect more deposits than loans, and remind yourself how valuable those deposits are, despite those extremely low rates. Deposits are the backbone of the bank.
- Sense of urgency in underwriting. Turnaround time is always relevant in lending. In small business banking it should be a competitive advantage. Many of your competitors use 100% automated systems. While I don't advocate this, given the credit risk, I also strongly believe that a 2-3 day turnaround time might not be quick enough. Aim for decisioning in hours, not days. Also remember that the customer doesn't measure turnaround time like we do. For them, the clock starts when they hand in the application, complete or not. For us, we typically measure from the moment a complete application hit the underwriter's desk. We need to align our measurement and expectations with the customers' timeframe (which makes getting a complete application in the first place even more important).
- Loan maintenance occurs in credit services area. Middle office must have specific performance goals. Small business bankers should not be burdened with obtaining loan maintenance documents. Their highest and best use is getting more loans and servicing existing customers for retention and additional business. Other areas of the bank, such as the middle office, are better suited for credit maintenance. The whole process can use rethinking: should you require document refreshers annually, or perhaps simply re-score your borrowers quarterly? Which process will protect the credit side best, and which will be the most efficient?
- Pay more like commercial bankers. You don't want your small business bankers to be commercial bankers in waiting, or, worse yet, those who couldn't make it in commercial banking. All too often the small business area becomes a stepping stone on the way up (to bigger loans) or down (to another bank). Make it a destination on its own, with strong incentives and institutional respect. While their loans might be small, typically the spreads and profitability (when efficiently managed) are manifold those of a commercial loan.
- Micro-accounts should be moved to the branch and serviced actively by call center. Bankers are loath to give up accounts, no matter how small. Yet they are often a resource that is too expensive to handle clients below their target markets. Move account servicing of micro clients to the branch or the call center. They can offer far better leverage of existing resources and still provide outstanding customer service.
- Bank staff needs to understand how valuable this business is. Small business gets no respect and it should. Share openly how profitable the business is, both in terms of cost of funds as well as yield on loans. It will open many eyes around the bank.
- Make commercial banking cede the small accounts; they will resist... As part of the rationalization of client allocation, move the appropriate small business clients to the small business unit. Commercial bankers handle larger accounts, and inevitably will generally spend less time cultivating this market segment. Give those clients to the bankers that will gladly spend time on their care and feeding.
- Branch manager working with business banking specialist is the prevailing model for loans up to $3mm. The typically coverage is a business banker per 3-4 branches. The banker lines up the deal terms and acts as the technical expert, the branch staff helps in sourcing the deals and then in client relationship maintenance and care.
- Loans and deposits are housed at the branch with double counting to small business. Shadow accounting is essential. Creating a zero-sum game among business units results in internal competition and lack of cooperation. Double-counting might be an accounting nightmare, but it is the foundation for collaboration since it creates a win-win environment.
- Covenants and terms should be cookie-cutter and standard. This makes both underwriting and monitoring easier and less expensive. There is no real need for customization in this business. If a transaction calls for much customization of terms and covenants, it might be better suited for the commercial banking world.
- Most banks score everything up to $250K, many up to $1mm. The model rules, minimal overrides. Many add a human touch to the score, having been burned in the past. This makes sense so long as the human eye does not fully underwrite the credit yet again. In such cases you get the worst of both worlds double the cost and half the credit worthiness. Credit scoring helps efficiency, but the underwriter scrutiny adds an important dimension to the process.
- Having small business as its own line of business is best practice. Small business has been known to report to retail, commercial and even operations. There are downsides to every one of these options. The retail guys often cannot provide the necessary technical and sales management support to the business. The commercial guys often cannot be bothered with these small loans. I have seen numerous notable exceptions to the generalizations above, so it ultimately all depends on the person managing the commercial or retail division. In most cases, however, treating small business as its own profit center and giving it appropriate management attention is the best way to go.
- You can either use a standard loan document or have key loan provisions that are consistent in every loan. Mass customization works. One-off customization is too expensive for small business loans. Have a small shelf of terms and covenants, and it should suffice to serve your customers' needs.
- Culture trumps the strategy every time, so reaffirming the credit culture is essential. This is true for any lending business, and small business is no exception. Inculcating the unwritten rules of your credit culture is at least as important as the scoring model itself.
- Use live case studies in the credit training program for the RMs. Teach credit mastery to all RMs and some BMs. Dummying down the sales force is not effective, as they will spend time chasing unbankable deals and will not grow to be the professionals they should be.
- Some successful niches: franchise financing (McDonald's); leasing (stainless steel lines for manufacturing); structured finance (define carefully), ABL (same; select a few assets and finance those; nothing broker originated). Niches are an effective way to grow the business.
- Benchmarks: What should you expect from your small business banker? Expect an average of 8-10 calls per week. As to annual production goals, they vary widely. On average, I see deposit goals of $3.5 mm and loans of $2mm in rural areas, $7.5mm and 3.5mm in metro areas.
Good loans and good relationships are harder to come by these days than ever. A strong small business strategy can help you achieve your financial goals in the community banker way, doing good and doing well at the same time.