I can still clearly remember my first kitchen injury.
When I was about five years old, I tried to saw through a head of lettuce with a butter knife, because my Mom didn't trust me with anything sharper. Progress was (understandably) slow, so I got impatient, reared back and stabbed at the lettuce. I missed my intended target and ended up jabbing the tip of the butter knife about a quarter inch into the palm of my hand.
A Sharp Knife Is Actually Much Safer Than a Dull One
This was a hard way for me to learn the truism that any decent chef is happy to share; a sharp knife is actually much safer than a dull one. Mom meant well in handing me the most harmless knife in the kitchen, but since it was so limited, I wielded it in a very dangerous manner. I see the same issue almost every day at work.
These days I’m no longer helping Mom with dinner, but helping bankers price and structure deals. Instead of knives, banks hand their relationship managers (RMs) software and procedures, but the truism still applies; the dull tools are the most dangerous.
At PrecisionLender, we sit in a fascinating intersection of our client banks. The pricing and structuring of deals is the junction between the “front” of the bank and the “back” of the bank. Specifically, we tend to operate in that fuzzy world where finance, credit, and sales all come together. Our platform is generally administered by a finance type, but used by RMs. The two sides come at the same problem with very different perspectives, and there is a natural tension in the process.
In most banks, the tendency of the finance types is to restrict the RMs as much as possible. Too much freedom, after all, can only lead to bad outcomes, and it is the job of finance to make sure that no harmful or unprofitable deals make it on the books. Much like my Mom, they figure if they hand the RMs the dullest knife (in this case the least amount of flexibility), there is less chance they will “go rogue” and do something harmful to the bank.
RMs, on the other hand, have the increasingly difficult job of rising above all of the competition to win over customers and book safe, profitable deals. Their customers are better informed and have higher expectations than ever before, and competition comes from all sides. And given a dull knife, they often have to wield it in unexpected ways to try to win.
The Problem With Pricing With a Dull Knife
Now that I’ve flogged this analogy to death, let’s take a look at what a “dull knife” really looks like inside of a bank.
In the most extreme cases, banks try to boil complex and unique commercial loans down into a grid. RMs are handed rate sheets, and told explicitly to stay within the guidelines for every deal.
We see one of two outcomes with this approach, depending on how strictly those guidelines are enforced. If exceptions are made, then those exceptions quickly become the rule, and the rate sheet ends up being ignored entirely. Nearly every deal is priced with terms that match the grid except for the rate. If, however, the rate sheet is strictly enforced, you end up with a different problem. With no flexibility, a very ugly selection bias shows up, and you win deals that you eventually wish you hadn’t. In essence, if they are willing to accept your cookie cutter deal, it might be because they had no other options from the competition.
Because of those common outcomes, we see fewer and fewer banks still using rate sheets for commercial lending. But, we do see plenty of restrictions on flexibility; even if almost any structure is technically allowed, by making approval difficult and slow, they are effectively off-limits to RMs. And these kinds of restrictions always have unintended consequences.
“Absolutely no caps on variable rate loans.” This inevitably leads to the bank booking more fixed rate loans than it otherwise would have.
“All loans must have a minimum rate of x%.” This has similar outcomes as we explained here .
“You must charge a fee of at least x%.” Forcing RMs to have the same fees on every deal leads to lower spreads and capitalized fees that increase risk.
“Annual payment structures are not allowed.” These banks often lose out on seasonal/cyclical business.
“All real estate loans must amortize, and the longest amortization period is 20 years.” Many projects are best served by temporarily having minimal debt service requirements (for example, as they lease up and stabilize, or make improvements, or the owners sell another property). With restrictions in place, your RMs will try to shrink the debt service through the only means available to them: a lower rate.
Customizing for the Customer
Today’s customers are used to being able to have service that is customized for them. They get exactly what they want, when they want it from Uber, Netflix, Spotify, or Amazon. And they are coming to expect the same in all of their interactions, including with their bank. This is why so many banks are seeing huge increases in policy and pricing exceptions, as RMs are trying to meet this demand by navigating tricky internal bureaucracy. They are doing their best to win deals with dull knives.
The best banks, though, have figured this out, and are arming their RMs with the sharp knives that allow them to safely win business in this new world. That means that you can no longer function with painfully long lists of “Not Allowed!” structures, and you can’t expect RMs to win deals when they have to wait days (or even weeks) for an analyst to put their exception through a cumbersome Excel model for approval.
They need tools that allow them flexibility in real time. All reasonable structures are acceptable, for a price, and RMs can function best when they know what that price is.
Show them the true cost of that cap, or the longer term, or of forgoing a fee, and let them find the combination that works for both the bank and the customer. The key, though, is that they need sophisticated tools that they can use. Does your homemade Excel model or the expensive custom software live up to that standard? If not, keep an eye on that left hand as you push RMs to chop more lettuce at an ever faster pace.
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