Thursday, November 16, 2023

How Will We Fund That Low Rate, Low Covenant Loan?

Emily McCormick's (Bank Director Magazine) most recent Common Threads newsletter post on LinkedIn got me thinking. How did that 5.5%-6% loan, described by Jeff Rose, CEO of Ambank Holdings, get to committee or even make it past the lender?

Banking is one of those businesses that requires bankers to be less stupid than their competitors. And when competitors start funding 6% loans with 5% money, they start pulling those in their competitive eco-system with them. Or they'll lose the loan. At closing, we don't know how well that loan will perform during an economic downturn. But we priced no credit spread into it. Heck, we didn't price cost into it, or interest rate risk, or liquidity risk, or risk-adjusted return on capital. 

So how can such a loan make it past the lender on that sales call?

Culture. As one bank CEO once told me, "you can't believe the improvement in lenders' negotiating ability when you tell them it's ok to lose the loan."

I recently spoke at the ABA Bank Marketing Conference on why product management is greater than product (a chapter in my book, Squared Away). In such a culture, you would have a director of product management, likely the CMO. But the product managers themselves would be sprinkled throughout the bank as close to the product as feasible. So the product manager for, say, the commercial real estate product would be an up-and-coming middle manager in that department. And he/she would be tasked with the continuous profit improvement of the commercial real estate product.

In comes Lender Hotshot wanting to do that 6% deal. If transfer priced at the FHLB blended 4-year borrowing then Hotshot would be assessed a 4.9% cost of funds, generating only 1.1% spread. If the prior quarter's CRE product spread was 3%, then Hotshot's loan would reduce the profitability of the product. If Hotshot went further out on the yield curve and was assessed, say, a 5.3% cost of funds, now he/she would only get a 0.7% spread on that loan. Multiply that by all the hotshots you have out there trying to produce volume.

But if Hotshot is only held accountable for volume, he/she is all good, right? Hotshot sits high on the lender production board.

But if the culture is continuous improvement, and the yardstick is profit, would this be so? If Hotshot was held accountable for the continuous profit improvement of his or her loan portfolio, credit quality, spread growth, would they even consider doing that six percent deal let alone bring it to their boss or a loan committee where committee members would ask "why so thinly priced" or "why the seven-year deal." The unspoken answer: "I have a $25 million production goal and this is what needs to be done to get the deal done." We created this culture.

In the product management culture, it would matter. That sharp SVP of CRE would have an interest in appropriately priced deals. He/she would interact with Hotshot to determine if there are product features that could help get deals done that don't reduce the profitability of the CRE product.

And Hotshot would get their quarterly profitability report, that not only measures their book of business, but also highlights those lenders that are top quartile in terms of profitability, spread growth, profit improvement. Maybe Hotshot will want to be on those lists. Maybe Hotshot is incented to be on those lists. Maybe Hotshot has been given permission to walk away from that six percent deal. Armed with that leverage, maybe they can get a better deal from that borrower. Or at least not hurt the profitability of his/her portfolio, the CRE product, or the bank's net interest margin.

But to get that culture. You have to measure it.

~ Jeff

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