Bank of Last Resort

In this competitive market, borrowers have options. Does your bank consistently find itself as the last resort that borrowers go to for that ultra-low rate? In this episode, George Neal and Jim Young will share insights from our latest white paper about how the best banks serve their community as more than just a commodity.

Podcast Transcript

Jim Young: Hi and welcome to the Purposeful Banker podcast. A podcast brought to by PrecisionLender where we discuss the big topics on the minds of today’s best bankers. I’m you host Jim Young, director of communications at PrecisionLender, and thanks for joining us. My co-host today is a first-timer on the podcast, George Neal. George is the new chief analytics officer here at PrecisionLender. George, before we dive into the meat of today’s podcast, why don’t you tell our listeners exactly what it means to be the CAO?

George Neal: Certainly. As the chief analytics officer, I work with the data insights team here at PrecisionLender. Our goal is to find insights into the data that we have that others may not be able to see simply because they don’t have this vast amount of data. We are in a very fortunate position. We see more loans than most major banks. We see them on a regular basis, and we think that we can turn that visibility into insights that are valuable to our customers and to the market in general.

Jim Young: Yeah, really translating that data into valuable information has been on our to-do list, our want to do list for a while. I will personally confess that I practically tackled George when he first came in the door at PrecisionLender because I was very eager to tap into his expertise. George, one of the first things we asked you to do was to help contribute to a white paper that we were writing, and then that we have since published, and it’s called Are You the Bank of Last Resort? We highly recommend it to you guys to download it, give it a read. We’ll have a link to it, the paper’s landing page, on our show notes. When you go to PrecisionLender.com/blog, you’ll see a little ad for that white paper there. You can click on it there as well.

Going into the paper, first things first George, can you explain what we mean by “bank of last resort” and on the flip side of that, what we mean by “bank of first resort”?

George Neal: Certainly. The “bank of last resort” and the “bank of first resort” are two extreme examples of mindsets that the market will have about a commercial bank. The “bank of first resort” is the smart, insightful, helpful, fear mitigating partner to an organization or a corporation. They’re the ones that when people talk about commercial banks in the market, they say, “Go to Bank of First Resort, make sure you talk to them about what’s going on in your business, let them bring the capital markets and you together in a way that’s going to help.” Then by contrast, the “bank of last resort” is the bank where, once all of that’s done, the customer goes, “Now, let’s go see if these guys will undercut that by a quarter point.”

Jim Young: Yeah, I thought back to my sports writing career. It was always for professional teams. It was before you pull the trigger on this trade, go check with this guy because he might be, for lack of a better word, enough of a sucker to offer even more on that deal.

George Neal: Exactly. One of the things that we’ve said a few times around here and I believe it to be genuinely true, it’s never a good idea to blindly match a competitor, and it’s a terrible idea to blindly match their rate. That’s exactly what the “bank of last resort” is going to do.

Jim Young: George, you haven’t been a CAO of PrecisionLender all your life. You were a banker in your previous life. During that time, did you ever come across a bank that, looking at it now, you would say, “Yeah, that was a ‘bank of last resort,'” or on the other side, were you like, “Yeah, the bank I was at, that was a ‘bank of first resort'”? Obviously, don’t have to name any names here.

George Neal: I’ve had the opportunity to work with more than five or six banks in my career, and I will share with you I’ve actually had the opportunity to work with one that made the transition from being a “bank of last resort” to being a “bank of first resort.” That type of transformation and being involved in it is a very exciting place to be, and it speaks volumes about the leadership of the bank. Yes, I’ve seen both of these models in action.

Jim Young: We’ll get to that a little bit later, but it’s a story we want to get across to people in this paper. If you look at it and go, “Oh my gosh, we are a ‘bank of last resort,'” that doesn’t mean we’re telling you it’s time to start looking for another job. We’re saying it’s time to start looking to see how you can become a “bank of first resort.” It’s good to know that you’ve got that real world example in your back pocket.

When we were talking about these sort of things, we spent a lot of time talking with our CEO Carl [rahy-deen 00:04:46], and he contributed to this and contributed a lot of the ideas on this. One of the ones that he had this particular line, “At the ‘bank of first resort,’ pricing is not merely assigning a rate to a commodity product. Pricing is the product.” What does that mean exactly? When you hear that line “pricing is the product,” what’s your definition of that?

George Neal: In my experience, there’s been two ways that banks and relationship managers look at pricing. One of them is to say, “This is the rate that’s on my rate sheet, and that’s the price I can offer you.” The other is to say, “Here’s the combination of levers that I have to meet your financial need that also achieves the objectives of the bank.” That kind of pricing, we refer to it as the capital P Pricing, that type of pricing includes all the elements of the deal structure, caps, floors, swaps, the quality of collateral. Importantly, it is the manifestation of the bank’s competitive advantage in the market as well. If your bank happens to be exceptionally good at collecting against real estate collateral, as an example, then taking a piece of real estate collateral allows you to be more flexible on other areas of the deal term. When we talk about pricing as the product, that’s what we’re talking about. Every lever that enables you to better meet your customers’ needs and enables you to manifest the advantages of your organization.

Jim Young: You got a little bit into my next question here because we touch on a couple of specific levers in the paper as we talk about caps and floors, and then we talk about rate granulary. Talk first about caps and floors and how that concept fits into the “pricing is the product” concept.

George Neal: Certainly. We started looking at high performing relationship managers, and when we say high performing, in the paper, what we said is these people do five times what we consider the expected amount of work. That’s a really high performing person. You’re not talking about someone who had a good day. You’re talking about someone who consistently brought the bank the income.

Jim Young: That is a relationship manager you want to hold onto.

George Neal: Exactly.

Jim Young: Yes, absolutely.

George Neal: When we look at these types of behaviors, we started looking at what differentiates them from their peers. One of the things that we found that was very exciting is exactly the use of caps and floors. They were five times more likely to offer a cap or floor in a variable or adjustable rate loan than their peers. What does that mean? What it means is that they’re trying to mitigate a concern on behalf of either the bank or the customer. If it’s the customer, clearly customers are concerned about the negative impacts of floating rates on their business. A cap alleviates that concern.

By contrast, they also wrote durations on those capped and floored loans that were one-fifth as long. That means that they understood the pricing of caps and floors. The further you go out on the horizon, the more expensive they get. Most customers, in our experience or my experience anyway, are not necessarily concerned that rates are going to creep up an inch at a time. What they’re concerned about is tomorrow morning I’m going to wake up and somehow I’m back to Reagan era three percent in one year rate increases. A cap alleviates that concern. It still gives them access to lower costing transaction. At the same time, by shortening the duration, it doesn’t leave the bank in a position to say, “Hey, I’m losing out on all potential future interest income that this customer could bring to me.” That match and the ability to make that match is critical. These lenders have been empowered to do that.

Jim Young: Yeah, you touched on that really good point. They’ve been empowered to do that. They haven’t been told, “If you have a deal, we can’t go above this rate, or we can’t below that rate, or we don’t offer these particular things in this situation.” That lender or relationship manager has the ability to say, “Okay, you’re worried about a short-term interest rate spike. Let’s talk about this. You might want fixed rate, but this might be what actually is going to work better for you.” Instead of also, we talk about it too, “bank of last resort” lenders a lot of times are order takers. You come in. “Oh, you want a fixed rate loan at this rate. Okay. Let me see. Yes, we can do that. No, we can’t.” End of conversation. What caps and floors touches on is a much more nuanced way at looking at that.

George Neal: It is, and it also manifests something that’s a philosophical core, I believe. That is everything that you take away from a lender, every tool that you take away from them and structuring and doing proper pricing is a deal that you leave on the table, it’s money that’s unavailable to you as a bank, it’s a customer you’re unable to meet the needs of. The more levers that this lender has, the better they’re able to properly price, by price, here again, I mean fully structure the loan, the better they’re going to be able to serve the community, grow the bank’s brand, and do all the things that a bank wants to do.

Jim Young: I know we talk about price. When we’re talking about pricing, we’re not just talking about rate, but rate still is a factor. It’s one of the levers, and we found some interesting stuff with granularity. Can you talk a little bit about that?

George Neal: Sure. What we found is that for these high performing relationship managers they use a much more specific and granular level of pricing. By that, I mean they’re not pricing on the quarters, they’re not pricing even on the eighths. We’re finding that they’re adjusting price down to the single basis point substantially more often. Now, in order to do that in a meaningful way, either they’re just completely making it up, which I don’t think is likely the case given the data that we have, or they understand the trade off of one basis point of rate versus the return that the bank is expecting and the risk the bank is willing to take and where that might be made up or earned out differently.

Jim Young: Got you. We, intentionally we’ll admit, put a little bit of fear into people at the beginning of this paper by asking that sort of are you the “bank of last resort” question and bringing them the concept. At the end, we bring in a little bit of hope at the end. We talked about this a little bit before, but it’s the idea that just because you’re in this position doesn’t mean you have to stay there, right?

George Neal: I think that’s true of most of the bad positions that a company can find themselves, and that’s certainly true here. Just because you find yourself, when you do that self-evaluation, saying, “Oh my goodness, I’m the ‘bank of last resort,'” that doesn’t mean you close up your commercial brand, shut it down, and let everybody go. What it means is that we have to figure out a way to empower your lenders to make these kinds of relationship deals. We have to give them better tools, better transparency, better knowledge at the time of the conversation. That’s critical in my experience. As I said, I’ve watched a bank go from being last to first resort, and the key element in that transformation was empowering the conversation of the lender with the customer. It’s not, “Hey, let me go back to my pricing guy. Let me talk to the guy behind the mirror, behind the curtain.” It’s, “I can talk to you right now. I understand what the trade offs are that we can discuss. I know how they work, and we can come to terms that I have confidence will be accepted, so let’s do that.”

Jim Young: Sounds good to me. If you’re interested in what George has been talking about or if you have a sneaking suspicion you might be working at a “bank of last resort,” we urge you to download the report and, again, give it a read. Again, it’s called “Are You the Bank of Last Resort?” Whether your bank is struggling or whether it’s wildly successful, we believe that you’ll come away with something of value from that paper. Again, we’re including a link to the paper’s landing page in the show notes for this episode, which you can always find at PrecisionLender.com/podcast. Again, you’ll find a link, an ad for the report on our blog page as well, PrecisionLender.com/blog. That’s all we have time for today. Thanks again for taking the time to listen. If you like what you’ve been hearing, make sure to subscribe to the feed in iTunes, Sound Cloud, or Stitcher. We’d love to get ratings and feedback on any of those platforms. Thanks for listening. Until next time, for George Neal, I’m Jim Young, and this is the Purposeful Banker podcast.