Questions Banks Should Keep Asking During COVID-19

May 12, 2020 Jim Young

In this episode, we discuss why - in the midst of the PPP frenzy - banks need to step back and consider some big questions. Two of the biggest: How they plan to tackle Main Street Lending, and what their risk profile looks like going forward. 



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Jim Young: Hi and welcome to The Purposeful Banker. The podcast brought to you by Precision Lender, where we discuss the big topics on the minds of today's best bankers. I'm Jim Young director of content at Precision Lender joined again today by Dallas Wells, our EVP of strategy.

And this conversation today is again, we sometimes like to pull back the curtain here and tell you guys exactly how the sausage is made if I can continue to mangle a couple of metaphors here. Basically what I'm trying to say is this is going to be a little more off the cuff. This is essentially a discussion that Dallas and I have been having. So it's going to be a little more free-form and it's really around the topic of we know banks are in day to day frenetic activity right now. Is this the time, can they, should they be looking at the bigger picture?

Dallas, I'll tell you I know sometimes I play devil's advocate in these conversations. I don't know how much I'm going to play devil's advocate in this one. So it may be I'm going to play skeptic and you'll have to convince me on this because it feels to me like lots of things are on fire right now. So I'll start it off with that. Is this the right time to be having this conversation?


Dallas Wells: Yeah. So fair question. And as we've talked to bankers over the last several weeks, first of all, those conversations have been rare and hard to come by. And it's because bankers are working 14-16 hour days, seven days a week sometimes to deal with everything that's in front of them. So the short version of what that is, we've got round two of PPP still alive. We've got preparations going on for the Main Street Lending Program. And this is interesting, maybe we'll get into this a little bit as we talk about it, but we've got forbearance requests and almost an entitlement and expectation of this is what's appropriate requests for forbearance or payment flexibility, et cetera. And you have all that happening, the banks themselves are dealing with their own version of this, which is spinning up an entire IT infrastructure to function remotely. Well, that's not at all how the banks were designed and that's not at all even how the disaster preparedness plans were written.

So I get that of the allotted time that bankers have, something like 120% of that right now is being used for disaster issues that are right in front of them. But it feels like this is sort of an existential crisis in some ways for banks. There's a few really key issues that they need to deal with. And somebody at the bank needs to be stepping back and looking at this from a strategic perspective, with a six to 12 month timeline, instead of from a tactical perspective and a six to 12 hour timeline where you're just dealing with whatever the most on fire thing is in front of you. That absolutely has to have the attention of a lot of people inside the bank. I think somebody has to, and I know lots of these conversations are happening, but banks have to step back enough from that tactical mess in front of them to really think longer term and perhaps make some really important decisions about how they handle things going forward.

Jim Young: Okay. All right. But given the predecessor people talk about a lot with what's going on with COVID is the Spanish Flu of 1917 or that, or that that time period, are we in danger of having a little bit of a World According to Garp sort of situation here where they're looking at a house and a plane crashes into it and he says, "We'll take it." And the wife says, "What are you nuts?" And he says, "What are the odds of another plane hitting this house," sort of thing. Is what you're talking about, are we having a conversation about, "Hey, this is what we need to be doing in case another once in a generation lifetime sort of thing hits our banking industry." What's the answer there? You understand what I'm saying? 

Dallas Wells: I do.

Jim Young: This feels like maybe it's-for a solution to a problem that may never occur again.

Dallas Wells: I do. And I think that gets right at the core of the issue and kind of what's on my mind as we have this conversation. And that is that a lot of the punditry and the talk within the industry is what do you do to be ready for something like this? And I think that's the exact wrong question. Instead, it's like, to confuse some more metaphors, It's like we're in the second ending of this thing and we're trying to plan well what happens when there's another game that looks like this one? Well, you got to finish this game first. And I think we have only just begun some of the economic pain and fallout that's going to happen from this and some of the implications for banks. So even if the virus issue itself were resolved tomorrow, if there's a vaccine tomorrow, there are follow on effects from this that are still a reality.

And of course there is no vaccine tomorrow. So we are still in the early stages of this. And I think people are coming to grips with the reality that maybe this thing is going to be with us for a little while. So let's use this as an example, even PPP. So the Paycheck Protection Program as a policy response to this problem. So the government response is, "Hey, we have a short term economic shutdown. And so in response to that, we are going to provide some short term liquidity to small businesses. And in fact, we're going to make this super easy. If you keep people employed, it's a grant. You keep the money. You don't have to repay it, no fuss, no muss. Here's a government grant to see you through this two and a half month." That's the number that PPP is geared around two and a half months for the payroll. Spend the money on payroll and all as well. that in no way addresses, I think the true extent of the issue.

So first of all, the economic pain is longer than two and a half months. Even if you just look at direct shutdown times and the ramp up and ramp down on either side of that. Just spinning up and spinning down business operations, that's more than two and a half months. And what we're starting to see as some states open up their economies is that you can't just flip a switch and turn this back on.

So the easiest example of that is over the last five weeks, we've had over 30 million new unemployment claims. That erases well over a decade worth of job gains. So 10 years worth of pretty solid sustained economic growth following the financial crisis. We erase that in five weeks and we're not done yet. The predictions of the unemployment rate going 15%, 20% somewhere in that neighborhood. Just because we say, "Okay, the official state lockdown orders are over," those 30 million jobs don't just immediately come back. I think consumers are going to be slow to feel comfortable going back out and spending money because of the economic issues, because of the health safety issues, because of some lingering restrictions, even. Like, "Yeah, you're open, but you can only have 10 people at a time in the building. You have to stay six feet apart." And all these sort of new rules that small businesses, businesses of all sizes are trying to figure out how to deal with. All of those things are kind of governors on economic growth and economic recovery.

So let's say that half of those lost jobs immediately come back, which maybe is generous. You're still talking about 15 million people that were employed five weeks ago, six weeks ago, who now are unemployed and are going to be making different purchasing decisions. So I think the economic implications of this are really deep and they're much longer term than two and a half months.

And so what you did is you gave a grant to some small businesses who fit within a pretty narrow window, and you bought them 75 days out of a yet to be determined number of days crisis. So what happens from day 76 forward? How many businesses decide, "Okay, that helped me temporarily stay open, but now what? Now this is still not enough to sustain me."

So I think those are the issues that banks have yet to address. And we're not talking about dealing with the next crisis that looks like this one. I'm talking about dealing with still what we haven't seen yet from this one, which is the true depth and extent of the economic fallout. We don't know what that looks like. The economy doesn't recover until the pandemic issue is done. We have no idea what that looks like yet either. So there's just too many unknowns, and I think any of the bankers out there can appreciate with that much uncertainty, you can't even really measure the risk. That's the true issue we have to deal with is how many of these borrowers are having a solvency crisis rather than a liquidity crisis. And which of those businesses are worth trying to save from a credit workout perspective, and which of them should we be just walking away from? And that's a hard question to answer as a bank, and I think that's the one that we're not willing to answer yet because we're going to let these government programs string it out as long as we can.

Jim Young: Okay. And I guess I will phrase the first part of it and then explain what I'm saying, which is (A) what's wrong with that basically, (B) because I guess sometimes the hardest thing to do and the smartest thing to do when faced with uncertainty is to wait until you get more information so that you have a clear path to go. And the instinctive human reaction is to try to do something right now. And I guess given what you just laid out there about all the things that we don't know, what exactly are you sort of advocating that banks should be doing given all those things that it's just so hard to determine at this point?

Dallas Wells: Yeah. So I think that's fair. Like so what? What do we do different? And this is where I think the issue is not so much what decisions do you make yet, but what things do you start putting in place so that you can make decisions? And I think even the use of the government programs, these are short term. So there's a ticking clock and there's a finite dollar amount. So there's only so much room that you have to do good with these, even if you look at it from a sort of altruistic perspective. And if you look at it just from a straight balance sheet protection perspective, you only have so many shots at this to save some of your borrower, so to speak. So right now it feels like banks are just kind of shoveling money out the door under a whoever qualifies gets the money sort of approach. And that's how PPP was designed. So banks are just sort of the conduit. And I think the public perception of it is that there was an obligation of them to handle it that way.

So I'm not sure that that was the right approach for the policy in general, and for the banks also to enact it that way. So that again gets back to how are banks going to make the decision over which businesses are actually viable at the end of this? And I think there are plenty of businesses out there right now who are getting funding aided by their banks that is not going to help them survive. To put it in really simple terms, you're throwing good money after bad. Where you're kind of flushing some potential help down with that business.

And my issue of what banks should be doing differently. They're not set up to make decisions this way. So credit analysis at a bank typically works like clockwork. You have borrower who is supposed to submit financial statements to you on some periodic basis. So let's say that you have every quarter, your borrower's supposed to give you new financial statements. So probably 30 days after the end of the quarter, you're going to get some interim financial statements that they've generated internally. Some months after a quarter or a year end, you're going to get some sort of review or audited statements that an accountants actually looked at and cleaned up the mess with. So let's say, we're looking at interim numbers and we're getting the most current view possible. So let's say 15 days after the month end. So right now as we record this, we're in early May. What you have in front of you right now is stuff from the end of March at best, probably not even that. And most of the lockdown orders were just going into effect in kind of mid to late March.

So from that you have a trailing three months or a trailing 12 months worth of operations of which about the last 10% was impacted in any way whatsoever. More likely you're probably looking at stuff that doesn't even include that period. You're looking at stuff from January, February, or even December. You're looking at 2019 numbers and trying to say, "Is this a healthy business or not?" Well, who knows? Everything has changed since then. So banks need to be able to quickly shift how they evaluate credit risk. So I think there are some pretty simple metrics that banks have direct access to that they should be looking at.

So for our clients, our Precision Lender clients, we have just dropped into their precision lender environment some new data sets that look at changes in cash balances for their customers and changes in line of credit balances compared to the commitment amount. And it doesn't take a lot of fancy math to look at what's the trend, how much room do they have left, and basically how much runway does that customer have. And so you can flag, out of thousands of customers, maybe you can flag 100 that looked like they have a runway of less than 30 days. And by the way, for our customers, there's a whole bunch more than that, that have that runway number we've calculated well below 30 days. But you should be able to triage and look at those that look like they might be in real trouble.

Cash balances are dwindling. Their access to credit is dwindling. Whether they qualify for PPP or not, again, that's a very short term temporary solution. And so that is a better indicator. That kind of crude, throw it in a spreadsheet and do the math on it is a better indicator than the sort of advanced credit review you would do looking at old numbers that maybe at best include a few days of this environment. That's an about face for banks of looking at different data, setting up new processes, getting everybody involved to agree that that's the best way to evaluate credit risk. And how do we decide if somebody that was a grade three should not be a grade five, that's always been based on their financial statements.

If it's based on something different, that's just well outside of the norm. Very few banks are even looking at that right now. Instead they are saying, "How many applications of PPP do we still have left to process? How many requests for forbearance do we still have in front of us? And who are we sharing with the product group or the tech group or whoever's kind of leading the initiative to get ready for the next government program?" There's very few that are looking at what's the best way for us to make decisions on which of our customers need help that we can proactively reach out to and that we can maybe make a difference to the businesses that have a chance of surviving and get them the funding and eat the losses on some of the other ones.

So that's I think the reality that very few banks have been able to face up to just yet.

Jim Young: Okay. I guess what I'm also then wondering is what you described there makes a lot of sense to me and let's be honest, a little bit of an advertisement for, "Hey, if you're a Precision Lender client, you can do this sort of thing." So take that a step back from that. And I guess what I'm wondering is is to what extent again, and I'm probably asking the same question but in a slightly different form, which is.... Actually I'll use the SOFR example, for Main Street on this. I put a comment on one of our things, which was basically they dropped SOFR thing and I said, that's probably a good idea. To me that was a bit like the parent after the child has gotten into a car wreck saying, "Here's how you should be driving," basically.

And I guess what I'm asking you still is, is there are a lot of PPP loans that have to get out the door. Main Street is something that they need to address right now. And what you're saying, I guess if I'm at a bankruptcy, I got it, Dallas, but house on fire. Now is not the time. And I guess that's still what I'm trying to figure out is it feels to me like you're saying now is the time and where's this middle ground here. How can banks that right now don't think they have the time make the time, I guess? That's the longest wind up to a question ever, but...

Dallas Wells: That's a long one. The last part is really hard. So let's start with the part before that. So to use your analogy, the house is on fire. Is now really the time to deal with this? Well, I think you're right the house is on fire, but my perspective is the fire is worse than is currently being reported and there's only so much water to go around. So the question is where do we best use that water to try to save some of the structure? And right now it feels like banks are just kind of spraying the water at whatever flames right in front of them instead of being strategic about it. So I think there's some foundational issues for banks to deal with that somebody in the bank needs to... And I think this has to happen at a senior level. This is not something for middle managers to tackle. These are big strategic directional issues for a bank. And somebody has to say, "Okay, I'm trusting my lieutenants to handle PPP and to handle Main Street. And I have to kind of think about business as usual and what's our true credit risk beyond that."

So we've put out some numbers that have sparked a lot of conversation over the last week or so looking at loan volume outside of the government programs. What those volume numbers really tell us is that effectively for small and midsize businesses, the credit market has been nationalized. There is nothing happening outside of the government programs. There's a few renewals here and there, there's a few workouts here and there, but who's going to their bank to buy a new piece of real estate right now and getting that done.

And I think in some ways the banks have been able to, and I mean this in the best possible way, again, we're coming from the side of the banks on this one. But I think the government's been a handy scapegoat here, meaning we can point at PPP and how chaotic it's been. And we can kind of throw all over the website, "Here's how many thousands of applications we've processed and how many millions of dollars of PPP loans we did and how many tens of thousands of jobs we saved." And all those things are by all means true. And we should be shouting those from the rooftops as an industry, anyone involved in that should be proud of that.

But it's also a handy scapegoat for saying, if anyone else is coming and asking for help asking for new funding, we can say, "Look, not right now. We're busy with this PPP stuff." You're dressing kind of the Macho Man Randy Savage super patriotic outfit. And you say, "Sorry, we're saving America right now. We don't have time to deal with that." There's some truth in that, which is great. That there's also some handiness to that of being able to say, "Not yet. I don't want to tell you no just yet and tell you just yet that your business has to fail, and I'm not going to step into the breach and give you the liquidity that you need." Those conversations have to happen at some point.

Our esteemed founder here at Precision Lender, Carl Ryden I think put it really well. He mentioned this to me in a phone call and he repeated it on Twitter. The regulators used to criticize a whole lot of banks for extend and pretend for effectively looking the other way on bank credits and saying, "Well, we let them skip some payments and we capitalize some interest and their own interest only for the next two years. Basically we think things will eventually get better." So extend and pretend and hope it gets better. That was a criticism in a whole lot of exams and rightly so.

Now extend and pretend is the official national policy of our regulators from the federal reserve on down. It is throw enough liquidity at this with no payments due for one year. And we'll come back in the spring of 2021, and I bet things are better and all will be well, even though there's a ginormous debt load we just added to this. And I'm not sure that's the case. I think as a bank I don't want to rely on government largess and their goodwill to continue bailing me out of this. I want to know that a year down the road I'm in good shape and that the borrowers I've kicked the can down the road with are the right borrowers. And that those that we should be not throwing additional exposure at to try to save here, I have a good way of making that decision.

So I think now is the time for banks to think about what's worked over the last 60 days, what are the decisions they're really happy that they made and that are guiding them in the right direction, and which things just feel antiquated and no longer appropriate man abandoned those things. So doing credit write-ups based on old financial statements, I know there's some banks out there doing that right now. You're gathering financial statements that into 12/31, and you're doing, you have somebody in your bank doing a writeup on those right now. Why on earth would you do that? Why wouldn't you have somebody who has the time and the capacity reviewing what those businesses cashflow prospects look like right now and who actually has some debt capacity came into this in a healthy enough situation that we can put a little extra debt on their balance sheet and help them survive this. And which ones came in too highly leveraged or not enough wiggle room or with not good enough margins, their business model just doesn't fit anymore. Now let's start putting those into different buckets.

And again, to go back to your analogy, as we start spraying water on this fire, let's point the water at the places where we can do the most good. I think that's the situation we're in right now. You can't save them all. So banks are going to have to be pretty pragmatic about that. We can't be the saviors for everybody. Instead, we got to kind of make smart decisions here. That's what's coming in front of us. And I think the sooner we face it and the banks that face it sooner will fare better than those who just keep waiting.

Jim Young: All right. So one final question on this, from my perspective, I feel like we've had a conversation. A lot of this has really been about a way of thinking and approach, a mindset for this sort of thing, which is one thing which is you can have that sort of shift pretty quickly. How much of this is stuff that there's only so much I can do with saying, "Hey, let's try it this way if I don't have the tools to do it that way." And again, this is going to veer toward talking about us and other financial technology companies out there, but how much of this do you need different tech for? And then along those lines, if you do need it, we just talked about how everything's on fire. Is this the time to be building a new addition onto your deck while your house is burning down? I guess to again go back to [inaudible 00:23:34] that for one last time.

Dallas Wells: So I'll use two examples that are not things that I actively sell. I don't build or sell or get compensated for any of these side. We'll remove the self-interest from this. Banks had to pretty quickly figure out how they were going to handle PPP. And there's multiple aspects to it. The first few, where we have figured out how to take applications and we can't have people come into the branches to do that. So that means we've got to have some way of an online way of taking loan applications and for a lot of banks, that was something that had been on the next year's roadmap for the last 10 years. And so it was forced upon them in really short order.

Then after that, they have to be able to figure out, well, how do we get those things actually uploaded to the SBA? And so you could either have people literally working overnight hand keying those things in, or you could upload them in batches, like some of the larger banks did and actually some small banks figured this out too. But there was a little custom technology there to be built.

There's also a lot of your customers who had little to no online presence before who are now trying to say, "Hey, we took cash and we sold lunch orders at the counter. That was it. Now we need to be able to take online orders and collect payment for people to come pick up curbside food. Can you help with that?" As a bank, can you? Do you have the capability to do things like that? So all that's a long lead in to say that there are some banks out there that actually solve some of those gaps in their own technology offerings. And again, trying to serve their own customers. And they had to skip their usual procurement process.

So if they wanted to be able to spin up a system to take PPP loan applications, the timeframe on that was so short that they had to evaluate vendors, sign a contract and start implementing it within less than a week. We talked to a few banks who looked at things like that and they're like, "Look, our procurement process, there's no way around it. It takes six months. So we just had no choice but to process these manually." Well, why is that okay? Why did you accept that as an answer and just look at your procurement department and say, "That's fine. We get it. We'll just pass on this. And instead we will gather people in a conference room and have them stand really close together and hand key in stuff to the SBA system, which may or may not work. And I'm going to tell my customers, 'I'm sorry, we don't have a way to help you gather these payments. You're going to have to go somewhere else to get that service.'" None of those, I don't think were acceptable answers.

So we've seen some banks kind of start breaking some of their own rules. We've worked with banks before this said, "We don't do cloud based services. We just don't do cloud things. We don't share data with outside vendors. We don't put data outside our own firewalls". All of that, once their employees were outside their own firewalls, how do you get them the data they need and how do you get the systems to actually function that way? All of those things, forcing some decisions on banks to where the practical thing is, you're going to have to figure out how to shortcut your own procurement process. You're going to have to figure out which of those rules you had in place that were for managing risk around data and around cloud and around certain kinds of system. Those risk management policies are now creating more risks than they're managing. You have to be able to step back far enough and say like, "Look, I know this has been your stance for the last several years. Things are now different. You have to change your mind for the good of the bank, for the good of our customers, for us to all survive, we have to get flexible."

So a good example of this, the entire world has started functioning on Zoom now over the last two months. It's the craziest thing I've ever seen. It went from this platform that we were using it at Q2, and we'd just started using it a few months prior. All of a sudden it went from this sort of niche, little video conferencing program to the thing to use. And so banks had to quickly figure out, "Wait, are we okay with this? Are we okay with people... Everybody wants to do their communication that way. Is that all right?" And there's a whole bunch of banks who are now saying, "Well wait, we didn't do the proper security review on this. I don't want my people having conversations on this platform." And I get it right. I get that there's proprietary information. There's customer information, there's security issues. There are vulnerabilities with Zoom.

The reality is to get things done, you might have to meet your customers where they are, which right now is on Zoom. So what allowances are you going to make for that to happen? And how much are you going to trust your people to say you can have a conversation with somebody on Zoom. If you're going to send information back and forth, use the encrypted email, use the tools that we have that are appropriate for those things. So it's just new territory for everybody. But for banks in particular, the ability to move fast and to be flexible is a muscle that some are good at and some are not. And I think that's going to be a real differentiator as we face this over the next several months.

Jim Young: All righty. I think you may have brought me around almost on all of this. So I hope as our listeners of this, I appreciate you indulging us on this, which is less of our scripted questions and this is what root topics and a little bit more of let's argue about something and record it while we're doing it. But I think it's an important conversation and if we're a little bit more blunt than usual, and maybe if we color outside of the lines a little bit on this, to go with what you're saying, Dallas, I think that's an acceptable level of risk right now, rather than just not have the conversations at all.

All right. Well that will do it for this week's show. Thanks so much again for listening. A few friendly reminders. If you want to listen to more podcasts or check out more of our, visit the resource page, Head over to our homepage to learn more about the company behind the content. If you like what you've been hearing, make sure to subscribe to the feed in iTunes, Google Play, or Stitcher. Love to get ratings and feedback on any of those platforms. If you've got more direct feedback or questions you'd like for us to research or discuss in a future podcast, feel free to reach out to me via email, And that'll do it for this week. This is Jim Young for Dallas Wells, you've been listening to The Purposeful Bank.


About the Author

Jim Young

Jim Young, Director of Content at PrecisionLender, is an award-winning writer with experience in a range of positions in media and marketing, from reporter to website editor to content marketer. Throughout his career Jim has focused on the story – how to find it, how to understand it, and how best to share it with others. At PrecisionLender, he manages the many ways in which the company shares its philosophy on banking and the power of relationships. Jim graduated Phi Beta Kappa from Duke University and holds a masters degree in journalism from Columbia University.

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