We recently surveyed commercial bankers to get their thoughts on how their bank would respond should the economy take a turn for the worse. Would they be ready? Would they change strategy and tactics? How quickly would they be able to act?
When their answers came back, we realized that the results alone didn’t tell the full story. Some additional context and interpretation were needed. We’ve provided both in this piece.
Do you feel like your bank’s portfolio is ready to withstand a recession?
Bankers don’t appear too concerned about whether their bank is prepared for tough times. If anything, they think their competition should be worried – 50% feel their bank is better positioned than their peers.
It’s understandable that bankers are feeling pretty comfortable at this point. Standards are certainly better than they were leading up to the financial crisis. There are pockets – certain industries and certain geographic regions - that have people concerned, but generally, banks are in pretty good shape this time around.
That said …
The last several recessions have shown that not everybody was in quite as good a shape as they thought. There are always things that surprise you. Many of these respondents put deals on the books and compiled their bank’s portfolio - they should feel good about the deals or they wouldn't be there. But history tells us that some of them are going to go sideways.
How much (if any) has your bank relaxed credit standards in the past two years?
Bankers were all across the board on this, with the number of respondents who said their bank was loosening standards basically equaling the number who said their bank was tightening. And then there was the large group who said their bank’s standards were unchanged.
So … which is it?
This isn’t just, "Would you say yes or no to a deal?" It’s also “Are you being a little more forgiving on standards?"
From what bankers are telling us in daily conversations, it's not necessarily that they’re saying yes to credits that they used to reject. It's that the credits that have always gotten a yes are now getting a yes without the same sort of restrictions or covenants, with longer terms, longer amortization periods, and fewer collateral requirements. That aspect of loosening is very much true, along with more favorable pricing.
Credit spreads - especially when you account for risk – have continued to get smaller and smaller. Bankers are saying, "Hey, we're being cautious. We're tightening standards. We're not letting things through the gates that we didn't use to.” But structure matters - especially when some of those deals go sideways.
The probability of default is what they're likely saying hasn't changed. But the loss given default is most definitely changing in the industry, and in a big way.
How well can your bank quickly change course in the event of a downturn?
This one was surprising. Granted, the whole “bank as technological dinosaur” stereotype is clearly outdated. But it still raised some eyebrows to see that so many respondents were so certain of their bank’s ability to pivot – and pivot quickly.
There’s some wishful thinking here. Or at the very least, a different reading of the question.
There’s a difference between changing strategy and just turning the faucet on and off - which is how banks have often reacted. If you look at the Federal Reserve surveys on tightening standards, they have the gray vertical bands that show where the recessions occurred. That’s where the numbers spike upward. Standards loosen through the good times, and then right as a recessions starts, bankers really tighten things up.
What's actually happening - and you can see this in the net credit created following recessions - is that banks’ reaction is to say: "That's it. No more new credit. Just turn it off." That’s not really a viable ongoing business strategy. It's hard to keep the lights on if you just turn off the credit.
To recap: Things go bad. Bankers turn off the spigots. They lick their wounds, they recover, and then they slowly start turning the spigots back on again.
What we're looking for is banks that can truly be agile during tough times and make the right sort of adjustments; the kind where it's not just all or nothing, but you can actually change the flow. Stop it over there, turn it up over here where there are actually some positive things happening, and basically redirect credit flow away from areas where you have exposure, to areas where you have opportunity.
Are 53% of banks capable of doing that? Absolutely not.
How well can your bank proactively spot changes or weakness in a customer, and take action accordingly?
Again, bankers are showing a lot of confidence in their institutions. More than 80% feel their banks can spot potential problems and 50% feel they act quickly when trouble is identified.
Meanwhile NONE of the respondents felt their bank identified problems too late to address them.
Maybe bankers are really just that confident. Or maybe their definition of “too late” is different from ours. For example, if a loan is past due, the ship has sailed on that problem.
Banks don’t automatically lose money when a loan goes past due. Most of the time they're able either work through the issue or go to those secondary sources of repayment and be made whole. That's why those deals are structured the way they are.
But once something gets wobbly, your risk-adjusted return on it is already way out of whack. Even if you get paid back, you’ve already taken a hit - in the form of the time and attention spent on the issue, the opportunity cost, and where else those funds could have been used.
What this survey question is about is this: Are there ways you can see problems coming before somebody misses a payment, before somebody's 45 days late and on their way to 90 days late?
Banks have access to tons of indicators. And there are a lot fintechs working on interesting ways of looking at more than just the financial statements that a borrower brings you. There’s all sort of customer information available in your bank’s systems: credit card data, outbound ACH data, deposit balances, lockbox receivables, etc. You are seeing the constant flow of their business, and you should have a much firmer grasp on when things are changing.
That's not just to look for warning flags, but also to look for opportunities. The banks that are now starting to get really good at cross-selling aren’t doing it by just harassing salespeople with, "Hey, did you offer a new credit card?" Instead, they’re looking for real opportunities and are actually using that data for something useful besides just making pretty charts in Tableau.
Our survey results show that banks don't view this issue as a problem that needs to be solved. To them it’s not something worth paying attention to and putting resources toward. Our fear is that the wakeup call only comes after another round of losses. Then they look back and say, "You know what? We had indicators that said this was going to happen, and we had time to act, and we just didn't."
Unfortunately, that's probably what it'll take for some banks, but there's a few others out there figuring it out. They're going to separate themselves from the pack when things do take a turn.
If/when a downturn occurs, my bank’s primary focus will be to:
With 66% saying a downturn won’t change their bank’s focus, does that indicate lessons learned? That this time they’re aware that something will eventually happen and they have already taken steps to not be caught off guard?
The behaviors that took place back in 2008-2010 aren’t new. We saw the same thing in the early 90’s recession, and the same thing back in the early 80’s. This is just what happens. So, bankers say they're just going to stay the course, and they don't.
Many of us who worked in banks back then remember sitting in board rooms and making lists of expenses that could be cut across the board. All we were doing was looking for money that we could either cut to drop to the bottom line or redirect to loan loss reserves. Basically we were asking: How can we build a giant cushion and go into turtle mode, just hunker down and try to survive?
On the flip side, there were banks like First State Community Bank, based out of Farmington, Mo. Coming out of the recession they went on the offensive. So when Bank of America decided to quickly shrink their branch footprint, First State seized the opportunity, bought dozens of branches and, in essentially a couple of years, doubled the size of their bank.
Fast-forward to today: First State’s margins are better, their return on equity is better, their return on assets is better. They are, without a doubt, a stronger, more profitable bank now because back when there was blood in the streets and everyone else was running scared, they were brave enough to step up and go beyond just staying the course to make some investments in taking market share. They're in new markets that are now growing and expanding, and it was the right long-term answer.
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