Saturday, June 08, 2013

Lessons Learned: Banks that thrived during crisis grew loans slower prior to it.

The St. Louis Fed recently performed a study to uncover the characteristics of community banks that thrived during the financial crisis. Thriving banks were defined as under $10 billion in assets, and maintained a composite CAMELS 1 rating in each exam cycle from 2006-11, an impressive accomplishment. As with most government driven academic studies, there were numerous answers. But one struck me as particularly instructive.

Former legendary Fed Chairman William McChesney Martin, Jr. once quipped "I'm the fella that takes away the punch bowl just when the party is getting good." It appears that banks that had the ability to do the same during the heady lending times of 2004 - 2007 found it to be an enduring strategy (see table from Fed study).

Banks that failed during the financial crisis did so predominantly for two reasons: over-concentration, and foolishness. Both are related. Banks that thrived, however, had the discipline to stay on the sidelines while their competitors did aggressively priced, borrower friendly structured, and competitor beating loans. 

Sitting on the sidelines is difficult. Competitors have snarky smiles on their faces when they bump into you at the local Chamber meeting or industry get togethers, knowing that their pipeline is fuller than yours, and they just beat you for the latest big construction deal. If we learn anything from this study, it is that at least one member of senior management should be like William McChesney Martin.

In addition to that, here is what I think a bank should do to avoid the lending hubris that led up to the crisis:

1. Lend Consistent With Your Strategy. I've seen my share of banks that "chased assets", to keep their pipeline as full as the bank down the street. But keep to your knitting. Be known to specialize in certain asset classes and/or industries. And, unless your strategy says "do land loans out of our markets", don't do them. Come to think of it, even if your strategy says to do land loans out of your market, still don't do them. And fire your strategists.

2. But Diversify. Being great at serving specific industries is critical to developing a competitive advantage, but it doesn't mean your balance sheet should be chock full of loans to one or two industries. It just means that you strive to be great at a few things. Continue seeking quality loans in other loan categories and industries. 

3. Minimize Broker-Originated Loans. For some reason, brokers that originate loans but assume no risk of default, don't care too much if the loan goes bad. Go figure? In addition, since the broker owns the relationship, the borrower may be more apt to default on your loan because he/she barely knows you.

4. Include Clawbacks in Bonus Pools. I am not a fan of regulators running your bank. But they favor clawbacks to deter profligate risk taking in lending. This makes sense to me. Keep two pools for each lender, and senior management. One for performance today, and the other for multi-year portfolio performance. Let lenders see that bonus pool grow and plan for the backyard pool when it is released, to motivate them to bring good borrowers and well-structured transactions to the table. 

5. Build a Better Lending Function. Populate lending with a few well-connected, experienced, and respected lenders. Then build a structure that is designed to develop junior people into your lenders of the future. Start them as portfolio managers, or credit analysts, with a targeted development plan. Banks that chased "experienced" lenders all over town ended up with those that made loans at all costs to get deals done. I've seen one or two of these "cowboys" bring banks to their knees. Just like I suggest not chasing deals at all costs, don't chase "experienced lenders" at all costs. Build your own pipeline of next generation rain makers.

What should I add to this list?

~ Jeff


  1. Jeff, great article. I would add something to the extent that banks should always know their customer and remain focused on customer service. It's one of the best ways to win a relationship, even if your pricing is not the "cheapest."

  2. Joe,

    Thank you for the comment.

    You are right. Not only does a strong relationship reduce the need to be the best price, but also, when the borrower runs into trouble, you may very well be the last creditor he/she continues to pay as agreed. At least that's what bankers tell me.

    ~ Jeff