Maria Abbe sits down with Katharine Briggs, EVP of Client Success at PrecisionLender.
With previous experience at a money center bank, a large asset manager, and most recently in specialty finance, she's led everything from underwriting to closing to post-closing of loans.
We discuss different types of bad loans, how to mitigate the factors that cause a loan to default, and lessons she's learned over the years when it comes to originating loans.
Katharine Briggs - LinkedIn
Bullet to Head - Moneyball
Maria Abbe: Hi and welcome to the Purposeful Banker podcast, the podcast brought to you by PrecisionLender where we discuss the big topics on the minds of today's best bankers. I'm your host today, Maria Abbe, content manager here at PrecisionLender, and with me today in the studio I have Katharine Briggs. She is an EVP here at PrecisionLender. Thank you all for joining us. Katharine is here today to chat about something that I would presume bankers try to avoid on a daily basis, and that is originating a bad loan. She's here to talk to us about how to not originate a bad loan. We're very excited to have you, Katharine, and welcome to the podcast.
Katharine : Thank you, Maria, excited to be here.
Maria Abbe: Katharine, as a first time guest let's start with the basics. Could you tell us a little bit about your background?
Katharine : Sure, Maria. I have a background as both a lender and as a borrower. Most recently, I've underwritten billions of dollars in commercial real estate loans. I have experience both at a money center bank, a large asset manager, and really most recently in specialty finance, running operations for a new single family home rental product. When I was there I led everything from underwriting to closing to post-closing of loans.
Maria Abbe: Great. What is your role here at PrecisionLender?
Katharine : Sure, I'm the EVP of client success. Everyday wake up and focus on how we can make sure our clients are successful in running their own businesses.
Maria Abbe: Awesome, thank you so much. Now, first things first, jumping in here to our topic of the day, can you tell us what exactly a bad loan looks like?
Katharine : Absolutely. First, there's really two kinds of bad loans. The first kind of bad loan is the one that most people think of, it comes to mind when most people hear bad loan. That's the loan that defaults. It's the loan that defaults in the first year, in the fifth year, in the tenth year, whenever it defaults and either the lender never sees any of their money, principle or interest, or receives a reduced payoff on the loan. That's the typical thought of a bad loan, is a defaulted loan.
What I wanted to talk about today was when we talk about bad loans is a loan that costs more to close than it's actually worth. On a related topic, a loan that may even never close, so you've spent lots of money working on the loan, and yet you never have an asset, a loan at the end. That's what I want to chat about today when we talk about bad loans. Those loans that never close or take a long time.
Maria Abbe: Yikes, that sounds painful. What exactly do you mean about the loan costing more to produce than it's actually worth?
Katharine : Sure. The business for banks, especially finance companies, lots of asset managers, is to close loans. That's what they're in the business of doing. A typical loan follows a path of a relationship manager builds a relationship and takes an application, often a deposit that goes with that loan application. The loan moves into underwriting where a lot of details about the loan and the borrower, and perhaps the collateral if it's a secured loan are vetted and verified. Then the loan moves into closing. The bank or lender advances the funds and the asset's put on the books. It's a pretty straightforward process. It takes some time, but it's a fairly well-worn path. Lots of processes are around that typical loan closing.
I want to talk about those soul-crushing loans, and those are the loans that either never close, they never make it onto your books, or they just take forever. More documentation is needed than was ever thought, the borrower goes radio silent for a while, questions that the RM thought they knew the answer to, once it gets into underwriting the answers are coming out differently. Those soul-crushing ones, they are tracked really through two primary concepts, two primary metrics. That's fallout and the days to close a loan.
Maria Abbe: Okay, I understand days to close. That's pretty straightforward. What exactly is fallout?
Katharine : Sure. You'll hear the term pull through and fallout, and pull through is really just the opposite of fallout. Pull through or fallout, fallout is the percentage of your pipeline that never closes, and more precisely those loans that go under application that you have a deposit on, but never make it all the way to funding. You'll hear, as I said, these terms pull through and fallout used somewhat interchangeably even though they're the inverse of each other.
Pull through is really all about efficiency and process improvement. If you view loan production as a manufacturing assembly line, and I really would challenge a lot of lenders to look at it that way, if you're running a manufacturing assembly line and the end goal or the end product for a lender is a good loan, how should you minimize waste? If you were running a manufacturing line you wouldn't want waste, excess supplies, excess product just scattered around the warehouse.
When you think about it that way, when you really try to trace through what's causing the fallout or what's causing that waste, I like to bifurcate it into two main categories. One, there's an unavoidable fallout. The fallout that really you can't see coming and it doesn't matter how well you know the borrower or the business or the market or the collateral, it's just unavoidable. A lot of those fall into the bucket of, the transaction just wasn't completed. The loan could have been, for an acquisition or for a purchase and that purchase just fell through. You can't close a loan if the borrower's not going to buy the property or the business.
The other unavoidable reasons for fallout usually fall under things outside of the borrower's control. For example, you could get third party reports that uncover unforeseen issues, like a title issue or a lower value than the borrower or even the bank's valuation group anticipated. You could uncover environmental issues. There could be regulatory changes during the time that you're trying to close the loan. There could be the closure of a major customer for your borrower. All things that are really outside the control of the borrower. Loans that don't close due to an acquisition that fell through or things outside the borrower's control, I call that unavoidable and no one should beat themselves up over those things.
It's the avoidable fallout which is really the most painful part of the bad loan process. You can kind of bucket those into three main subgroupings as well. One: you've got a borrower who continued to shop the loan and they found a better solution. That should be troubling for a lender. Why didn't you as a lender, for a loan that was under application, why didn't you have the last look? Why was the borrower still out shopping the loan that you were so diligently trying to close? I think you see this when you see some teaser rates or teaser loan packages where there's no due diligence fees or no loan application fees. If you're really deep into the financing process your application fee, the deposit that the borrower paid should be sufficient to keep them committed to moving forward with the loan process.
Other avoidable fallout really falls under credit issues. Should you as a lender have known more before you began the financing transaction? If you just asked more questions would you have uncovered something? This is certainly a great reason why relationship based lending is a good investment of internal resources. That way you're not surprised by a borrower's bankruptcy or a foreclosure.
The last avoidable fallout that lenders should look to steer away from is pricing, and I'm not talking about a competitor coming in and beating you up on pricing like I was in the first example, but rather I'm talking about a loan in which the credit officer is signed off on, they're happy with the credit, but your treasury or finance professional says, "Yeah, we're not going to do the loan at that coupon. That doesn't make sense for us." In short, those are the loans where the originator has really mispriced the loan and has to go back to the borrower and re-trade the entire transaction, which as you can imagine goes over like a lead balloon.
Maria Abbe: Yeah.
Katharine : What I find really compelling and interesting, and quite frankly perplexing about the commercial loan space is that the resi mortgage business tracks fallout and days to close really religiously. I was telling you earlier those are metrics that are closely followed. On the resi side, for example, the fallout in April 2017 was about 30%, but in 2012 loan fallout was over 50%. That makes sense. We were going through a much different part of the resi home loan cycle back in 2012.
Days to close, again, the resi mortgage market is tracking days to close really closely, and it makes sense because they've got rate locks on these loans. In April 2017 it took 42 days on average for a resi mortgage originator to close a home loan. Again, earlier in the cycle back in 2011 and '12 it took almost 10 days longer. The resi loan shops are tracking all of these days to close and fallout metrics and learning from them and improving their processes and trying to minimize waste, if we think about that manufacturing assembly line.
Very few commercial loan lenders are tracking these types of metrics. I think it's because a lot of the commercial loan lenders feel like the loans are so idiosyncratic, and there's so many differences from one loan to the next, whether it's the structure, whether it's the market, whether it's the collateral, whether it's the borrower that it just doesn't make sense to track these type of metrics from one loan to the next. I really think there's a lot that can be learned by studying your own pipeline.
Maria Abbe: Yeah, now are there any buffers that banks can put into place for the unavoidable reasons for fallout?
Katharine : There's really not. Those things really kind of come out of nowhere. Most banks expect a certain amount of slippage or waste around unavoidable fallout. It's really just the cost of doing business, and a lot of that is factored into the way they price the loans and the type of overhead that are applied to all the loans. That is, again, nothing for any lender to beat themselves up about.
Maria Abbe: Gotcha, but it sounds like the better that banks are at tracking, the more precise they can be.
Katharine : Yeah, absolutely. Well, here's the thing. There's clearly a cost component to having a high fallout and a lengthy days to close metric. There are real financial costs associated with having a pipeline that takes months and months to close and has a fallout rate in excess of 40 or 50%. Those are loans that people spend a lot of time on, internal resources spend a lot of time on; credit officers, closing managers, relationship managers. There's a lot of labor costs associated with that. There's also, not surprisingly, a lot of intangible and unmeasurable costs associated with having a pipeline with really high fallout and lengthy days to close.
Maria Abbe: What are some of those?
Katharine : Not only is the bank or the lender, their reputation is taking a hit in the marketplace.
Maria Abbe: Yeah.
Katharine : Yeah, the human, the relationship manager, even the credit officer that has to deliver that bad news, their reputation's taking a hit as well. From the customer standpoint, you know, the repeat business falls. Borrowers start to look at your bank as the lender of last resort, or they may only transact with you if you can beat your competition by a really wide margin. Even if you beat your competition by a really wide margin, they're probably still shopping you the whole time that you've got that loan in due diligence.
From the relationship manager perspective, these intangible, unmeasurable costs with fallout and days to close, it really depends on whether the fallout was due to changing or arbitrary bank credit policies or if it was a lack of understanding of that one particular relationship manager. The bank should be able to by studying the pipeline, be able to ferret out if it was a lack of understanding, if the RM really did not understand the product he or she was selling by studying the pipeline stats, because that relationship manger will have markedly worse pull through results than all of her peers.
If the issue is arbitrary policies, or maybe credit policies that aren't being clearly communicated internally, those sort of issues inside of a lender will really kill employee morale, cause a lot of employee turnover, and set up a pretty poisonous relationship between the credit sales and treasury groups of a lender.
Maria Abbe: Yikes. What's your recommendation to fix all of this?
Katharine : It's pretty straightforward. Doesn't mean it's easy, but it's study your pipeline. Whether a bank or a lender has a robust integrated CRM type pipeline or whether they have a crude Excel one, track that fallout and track those days to close. Track it by loan originator, by relationship manager. Track it by region. Track it by product, but loan size, by leverage, by all sorts of statistics that are at your fingertips. Don't just leave it to the resi mortgage lenders to be tracking it. Commercial lenders can learn a lot from this too. Once you're armed with several months and quarters of data, most lenders will be surprised by where their team is being bogged down in those bad loans, those loans that take a long time to close or never do close.
Once you've got all that data the lenders should study their formal and informal sales practices. Are you the bank that's known for a bait and switch? That's certainly a strategy, but make sure if you're the bank and switch lender in your community that you're pricing for that fallout and that customer displeasure and bad reputation and employee angst. Some lenders might find that brokered loans may be a big drag on their performance, and it's better to know that than not know that. Again, not suggesting that any of these strategies are bad, but you've got to know what the implications are, what the impact is of the strategy you're choosing.
Do you have, for example, relationship managers that may be paid purely on performance? If you've got a workforce that's compensated that way and you don't have safeguards in place, those RMs will rarely see a deal they don't like because there's no down side for them to have credit or the ops group kind of spinning their wheels on these bad loans. Make sure that the incentives for the RMs are aligned with your bank strategy.
There are lenders out there who make a business out of financing tricky assets. Rest assured, they're getting paid for that level of complexity. Make sure your bank, if they're doing those tough deals that they're being paid for that. Maybe you've got awesome RMs and the best process out there, but you've selected a tough industry, a tough asset, a tough market, whatever it happens to be. Own that, but make sure you're pricing accordingly.
Then finally, the last piece of advice or lessons learned over my career of lending is to put yourself in the shoes of the borrower. Maria, I often think of that scene in the movie Moneyball with Brad Pitt and Jonah Hill where they're talking about how to fire somebody. Jonah Hill is hmm-ing and hawing and saying all these nice things and really trying to avoid a difficult conversation, and Brad Pitt aptly says, "Just say no. Fire them." Sometimes the uncomfortable situation, the uncomfortable conversation, you got to have it. Have it quick, have it early in the process, and live to go make another loan.
Maria Abbe: I love it, thank you. We'll link to that scene in the podcast recording so everyone can check that out, too. I think that will do it for us today. Thank you so much, Katharine for being a part of the podcast with all of this great insight. Thank you all for listening. If you'd like to hear more, you can visit our resources page at precisionlender.com. If you like what you've been hearing, make sure to subscribe to the feed in iTunes, in SoundCloud, in Google Play or Stitcher, and of course we would love to get some ratings and feedback on any of those platforms as well. Thanks again for listening. Until next time, this has been Maria Abbe with Katharine Briggs, and you've been listening to the Purposeful Banker podcast.
About the Author
Follow on Linkedin
More Content by Maria Abbe