Commercial banks are out of survival mode and have at least grown accustomed to life with COVID-19. There’s time now for them to ask “Okay, what’s next?”
In this episode of The Purposeful Banker, we discuss some of of the potential answers to that all-important question.
Small Business Lending: Digital Is the New Normal (American Banker)
Are Banks Taking a High-Risk Approach to Risk Mitigation? (The Purposeful Banker)
COVID-19 Market Updates & Resources (PrecisionLender)
A Recession Is the Time for Banks to Get Ahead (PrecisionLender)
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 your host, Jim Young, director of content at Precision Lender. And I'm joined again by Dallas Wells, our EVP of strategy.
Today's topic is a broad one: what's next for commercial bankers? Don't worry, Dallas, I'm going to give you a little more context before we div
It's been a whirlwind to say the least for commercial banks since the beginning of March, but we're nearing the end with PPP and it's no longer occupying every waking hour for bankers. And though things are certainly not back to normal economically with COVID-19, banks are out of that survival mode and have at least grown accustomed to economic life with the virus.
So there's time now for commercial bankers to take a look around and ask, okay, what's next?
Dallas, what are the most likely answers to that question?
Dallas Wells: Yeah. Good question. The conversations we've been having with banks, we tend to see that answer fall into one of three buckets and those buckets are very different. The inconsistency within the industry is surprising. I don't think it's unusual for a crisis like this, but it is surprising how all over the map banks are in their responses to this and kind of expecting what do we do now?
The first bucket that we hear is it's time to get back to normal. It's time to just resume business. There's big chunks of portfolios that have been put on forbearance and banks have worked their way through at least most of the PPP applications and fundings. Now they're on the back end, dealing with the actual forgiveness of those and deciding how they're going to handle the Main Street lending facilities.
But it feels like that stuff is, at least the planning and the strategy for that, is largely done. And so the banks are ready to say, "Okay, the economy's opening back up and it's time for us to figure out which borrowers are ready to move forward in more of a normal environment and start to separate out. There's going to be some credit issues, we'll work those out, but for the most part, it's back to business as usual, we need to get back to growing. We need to fund new loans. We need to find customers that are just ready to resume things. It is very much let's get back in the office, let's get back to work and this was all temporary. And off we go now just on the same trajectory we were on."
The second bucket is one that I think is pretty interesting actually, is that COVID has been like the great accelerator for a lot of trends that were already in place
. I think we see that across a lot of industries and in banking what that means is that these digital transformations, to use that term that probably gets overused and doesn't really mean anything anymore. But the investments in technology have been accelerated. So banks had to, if you look at the spike in volume, just the massive volume of deals that had to be processed just for PPP and then all the forbearance requests and just asking for help from customers, it was this wave of volume that we've never seen before and it came out of nowhere and there was a really short time frame to deal with it. So banks kind of on a shoestring had to put together some digital systems just to be able to survive that, you literally couldn't touch all those. So you had to make these digital platforms to be able to handle a loan application, make a decision, route it to the SBA, get money funded.
They built these things really quickly and they used some vendors. Some of them built it in-house. Some of them did hybrids, but they figured out that, Hey, that worked. We did that. We survived the volume and now we actually have some, at least a really good starting point where now they can refine what's already there. Between that and the fact that some of the bankers that fall into this category feel like this is not just temporary, there's going to be some lingering effects of this and maybe everybody can't come back to the office. Maybe customers are going to be more reluctant to come in and meet us face to face. We're going to need more digital channels to be able to interact with them. All banking is digital to some degree now. And so we have to give that opportunity to our customers to interact with it that way.
So I think there's some banks that are saying, okay, now that we're through the worst of it, let's spend the next period of time figuring out how do we continue the momentum that we've started here in going digital with all things, even the kind of people, relationship heavy commercial lending business.
Then the third bucket is the it's recession time crowd. We'd love to get back to business as usual. We would love to build some technology platforms. We have neither the time nor the budget for either one of those, because it's time to batten down the hatches. We're going to see some real ugliness in the portfolio. It's time to triage. It's time to figure out which borrowers are really in trouble. We're going to forget about growth for a while
. It's time to refill the loan loss reserves and just be ready for what's coming and we're focused on working through credit issues and everything else comes after that.
You can see we're at this crossroads where there's three very different paths forward. That's what makes it interesting in talking to banks, you get this wildly different conversation depending on the bank, and sometimes even who you talk to at the bank. And I think some of those will come together and that there will be some right and wrong answers out of that. But I think right now there's very different paths that banks are going down and different sets of decisions that they need to make.
Jim Young: Yeah. And I would guess also with that, there isn't necessarily a right or wrong answer because of different banks, different circumstances, et cetera. Let's dive a little deeper into each of those areas. And I say that with a little bit of trepidation, because first up is digital transformation. And I think I'm on camera now, these, we record them. So I have to be careful that my immediate reaction is, because my immediate reaction is normally to roll my eyes when it comes to this one. If I had a dollar for every time, I've heard the words banking and digital transformation in the same sentence, or frankly written it myself, I like you Dallas, I like Precision Lender, but I think I'd probably be retired to a tropical island at this point.
But on a serious note, why do those words, I don't feel like we've had this conversation. All right. This is going to be the thing that's going to trigger digital transformation. This is going to be the thing that's really going to push it. And again, I should say for commercial banks, why then is this one? You laid out some of it, but why do you think it's this time around it's going to stick for commercial banks?
Dallas Wells: Well, I think this was the strange confluence of events that all landed at the same time. It was like a great forcing function. So it went from when you have this conversation about digital transformation, I think this is where maybe some of the skepticism comes from. Everybody agrees it's a good idea, right? There's nobody who says, Oh, that's hogwash. We're never going to go digital for any part of this. It's always a we would love to, but not this quarter. We'll put that in next quarter's budget. And it always gets kicked down the road a little bit. The big aspects of it do. Well, there wasn't the next quarter this time. The program, the PPP program was announced, and you had like two weeks to get ready. And the final program rules were actually announced the night before. So banks are on a whole different timeline than they've been used to on this stuff.
Again, for the commercial piece of the business, which is still relationship-centric. There's still bankers that are dealing with customers and that's a personal relationship that I don't think is going away. But then a banker could say, here's this link, go upload all your documents and fill out the application there and we'll route it all through there. And I'll be here to answer questions. You can call me, we can talk about it, but that's where the actual conveyor belt of this request turning into money in your account happens. It has to move down through that process. Banks had no choice but to do it that way. There were some community banks who gathered people in a conference room and typed these things into the systems by hand. But I think they even realized like, yeah, we can do this as a temporary thing, this is not a permanent answer.
That combined with the fact that the whole world had to go a little bit digital. So even those customers who have been reluctant to use some of the online banking platforms, or they don't want to do email, they'd rather talk on the phone or they'd rather come see you. They couldn't come see you. It was this kind of forced distance. There was Zoom meetings happening with people who've never done such a thing before. And I think everybody got a little bit of a comfort level with it because they just had to adapt. And so now that they've seen it, it's okay, that wasn't so scary. From the bank side it's we actually made good progress here. We got some good foundational in place. Some of it was a little rushed. There's some paper clips and chewing gum holding some of this together, but let's go back and fix that and let's make this a real thing now for if we want to take online loan applications, we now have most of the infrastructure to do that. So let's make that happen.
And then the final thing that I think will help here is the realization that the regulators are going to be okay with this. In fact, the regulators encouraged all of this. So things like e-signatures that, depending on which bank examiner walked in through the door, some of them were like, Oh yeah, totally fine. See it all the time. No problem. And others were like, yeah, but is it really the same as wet ink on paper? How do you know for sure? I think that attitude has actually flipped around now. And there's a lot of comfort with, from the regulatory side, on how those processes work. And there's a trodden path now.
I think all those things combined make this, those things were going to happen, they were in the process of happening. Some banks were already there. This was just like the forcing function and the great equalizer to say, now everybody has to do it this way and your customers are going to expect it. Now, if you go back and you say, Oh, you can't apply online anymore. You got to come in this time. That's going to be a strange message to deliver to your customers from here on out.
Jim Young: Right. Okay. The second category is the one that if I was a betting, man, I would think would be the most popular answer when you ask the banks and that is risk mitigation, but let's not go to 2008 the Sequel here. But to me, when I think about this, there's some complicated factors here. You never know what's around the corner, obviously, that's the whole reason why banks have this whole business model, but this thing's so uncertain and the potential outcomes are so wildly variant. I just wonder how you can sort of model risk in that environment. And then all those deals that were made five years ago that now look really bad on the portfolio are on the portfolio. So how much can you do with those at this point?
Dallas Wells: I think you hit on the key factor there, which is banks are a, even community banks, it's a high volume, low margin business. You have to make a whole bunch of loans on really thin margins and hope that most of them do well. So when you get these periods of high volatility and lots of variance and potential outcomes, you can't really model it. And especially one like this, there is no scenario that you can break out where it's like, Oh, we've seen this before. We haven't, not in modern time. So there is no expected outcome that you have a high degree of confidence in. So even if you're thinking this is temporary, our local economy is fine, things are reopening, all good here. There is a realistic possibility that you're just dead wrong. Even if that's pretty low, let's say it's 10% chance that you're wrong and there's a second wave coming. And it hits locally and a lot of local businesses and your customers have to close down.
In the banking business, if you're wrong 10% of the time, not only are you out of business, you actually might be in jail for losing some shareholder and depositor money. This is not that kind of business. This is a business where you have to be right 98 or 99% of the time. And that's simply not possible right now. And that's why I think you see a lot of banks saying, okay, even though this looks like all the economic numbers point to a pretty quick bounce, and if your local markets look pretty strong, because of that potential for bad outcomes, there's a lot of banks saying we can't do anything about the deals on our books, but we can restrict spending.
So there's budget cuts, there's no new hiring, all extra dollars get routed to loan loss reserves, and we get really tight on credit standards. And so if your line of credit comes up for renewal and you've been a great customer for 10 years, I might still ask you for some new collateral. If you've got a balloon on your real estate loan, maybe we shorten the term. Maybe we ask you to start terming out some of this debt that's just been kind of sitting out there, an evergreen line of credit. Those banks are going to, wherever they can, start to reduce risk and get tighter on standards and tighter on structure. That is until the level of uncertainty goes down a little bit and we can see a clearer path forward. It makes sense that there's logic to it for the type of business that banking is.
And maybe this is where we talk about the third group. You still have shareholders to answer to though. You still have to generate returns in the business end. So while it may make sense to, for a while, go into recession mode, even while you're in the middle of it, you have to keep asking, continually, every week, every month, is this still the right answer or are we now overdoing this? And we're going to spend too long in this mode and we're going to get left behind. We're going to lose market share. We're going to lose good customers. We're going to lose potential profits.
Jim Young: Gotcha. I'm glad you transitioned into that third and final area because that's the one that I'm, granted I'm also a glass half empty person in general, but the one that kind of puzzles me is this idea about like, Hey, we got to go out there and close some new deals, bring in some new clients, that sort of thing. And even if the bankers are ready for that, I guess first question is are clients out there saying, Hey I'd really like to leverage myself a little bit more right now. I'd like to take on some more debt. That's sort of my first question. And then again, like how do you have that deal conversation about what your usual terms are when things are that we talked about, the range of outcomes seems so wide right now?
Dallas Wells: Couple of things there. And one is a little tricky so we'll do it first, we'll tackle it first. It feels like we're early in the economic fallout of this. And so there's a lot of, if you go back to the financial crisis. In 2008, and actually some numbers started looking funny in 2007, in 2008, early in the year, it was clear that there was some wonkiness happening and Bear Stearns actually failed very early in the crisis. There was still a whole lot of business as usual bankers and there was a whole lot of business as usual deals that got done. And that's the case now too, where people were like, look, I was in the market for a piece of commercial real estate, not that big of an impact here locally. So I just carry on and I go to the bank and I say, I'm ready to finance this thing. And what's the bank going to do say, no, we don't do those anymore. For a good customer and a good project? There is business as usual happening at every bank in the country right now.
So I think what we're really talking about is are there some banks that maybe, and again, to go back to 2008, they kept doing business as usual for too long. And some of those final deals that went on the books were actually ended up the ones that were their biggest losers. So I think even if you are in the business as usual crowd of when your good borrower asks for financing on a new project, maybe you still evaluate it mostly as you would before. And you still say yes, like you would before, but maybe you do require more equity in it. Maybe you don't let them get quite as thin as you have on the last couple of projects, you make them write a real check to put some equity in there and not just carry forward equity from prior projects, which happens with a lot of these CRE deals. Maybe you require more personal guarantees than you used to. Maybe instead of a five-year balloon, you do a three year, there's little things that I think you can do that can help even as you get back to business as usual.
Because if you look at then what happened in 2009 and 2010, 2010 is when most of the bank failures actually started to filter through away from Wall Street and into your regional and community banks. It took a while to land there. And there was a whole lot of bankers because I was in the rooms of some of those, employed by one in particular, where it was like, boy, there's a couple of deals we did there that we really wish we hadn't. We should have gotten more careful earlier. And we shouldn't have just looked around and thought, this is a Wall Street problem. This is a bond market problem. This isn't us. It was us. And I think there's going to be some of that here too, where, especially because 10%, 20% of your book is in forbearance. How do you know who's in trouble? How do you really know when you're not asking them to make payments right now? Or they just got PPP funding, or they've just kind of closed the doors and then when they reopened, nobody comes back. They lose their revenue source and you don't really know that yet.
So there's lots of ways to excuse what's happening right now as because of the lockdowns and as soon as things are truly back open, all will be well. Not all is going to be well. There will be repercussions of this. And so a lot of these bankers that say those look like somebody else's problems, we underwrite really strong credits. Everybody feels like their portfolio is the fortress balance sheet. They're like, yeah, I'm sure there will be big losses in the industry, but not with us. Well, somebody is going to have those losses and so I think some of this is that. The different outcomes for different parts of the country right now is again, something that we haven't seen before. There are plenty of regions of the country that have not been impacted that much by this.
So not much virus impact, pretty limited lockdown impact. And then once they said, okay, open back up, everybody rushed outside because they're like, it's fine here. This is not something we're worried about. So in those places, I think when those banks say, Hey, we're ready to go back to business as usual, for now they're right. There is no reason to be overly cautious.
So this to me is the trickiest category. Those are the trickiest conversations to have with some of our clients who insist that it's like, look, this is not a big deal. We don't want to talk to you guys about that stuff anymore. We're ready just to talk about business as usual. And we're like, are you though? Are you sure that you're actually ready for that? And I think time will tell, so we will see. But that to me is the most concerning one is when bankers are saying this is fine. That one I have the most questions about. The other two make sense, this one I struggle with.
Jim Young: Gotcha. All right. Well, to sort of simulate the way that bankers are having to make important decisions with a lot of incomplete information, I'm going to ask you a question now that I didn't actually send to you before the podcast recording. We've kind of gone through each of these and you've given sort of pros, cons, and potential pitfalls and reasons to do it and reasons not. So put yourself in that CEO of bank or head of a line of business bank position, and someone asked you that question, it seems like you'd want to be able to do a little bit of all three in selected ways, but is that, I don't want to feed you your answer, I guess what would your answer be? And if it is something, can it be all of the above?
Dallas Wells: We used to ask clients when we would bring them on to Precision Lender, we would say, look, as we're calibrating everything, and Precision Lender is a tool that is meant to shape behavior of relationship managers. It's meant to point them in a direction. So as you change the strategy of the bank, you can kind of shift their attention where you want it to be. So we would say, look, you can focus on profitability. You can focus on growth. You can focus on managing risk. Rank those in your order of preference for your current strategy. And that will change through the business cycle but what is it right now? And they're like all three. Put them all at 11, max them all out. We want all three, as much as you can get. And that's not realistic. There is a natural trade off.
If you want growth, you can't also be the most profitable bank. You can't have the biggest spreads, the lowest risk and the most growth. Not sustainably. So there are some natural trade-offs there and I think there's clearly some trade offs between these three strategies. And I think you got to pick, you've got to pick a lane that you're in. You can't halfway do true recession disaster preparation. If you really think that this is going to be, and I've heard some bankers say this, this is going to be as bad or worse for our industry then the financial crisis was, I think the economic fallout is just going to be worse. Then it's not time to do a big digital transformation and it's not time to go back to business as usual. It's survival mode if you think it's that bad. And same for, if you're ready to do a digital transformation, you can't do that with the backdrop of the world is ending.
It has to be with this eye towards, yes, we're clearly going to be dealing with some credit issues, but we're ramping back towards business as usual and we want this to be the foundation on which we can kind of make the next leap forward. So there will be some elements of all three, but I think you have to pick. And I think it's going to be a little bit market dependent, but I think wherever, as long as you think your bank is going to come out the other side, and I haven't talked to anybody who has any doubts about that yet. The banking industry is incredibly healthy coming into this and is still faring very well, even through some tough times. If you think you're coming out the other side, do you want to be the bank that comes out the other side without the digital capabilities? Even in our own business here at Q2 and at Precision Lender, this was a time for us to look around and reevaluate some things because it was not business as usual and it's still not quite business as usual.
In our case, we sent everybody home really early. So we've all been working from home since very early March at this point. There's a lot of the folks that I work with that are like, Hey, do I have to come back? When the office has reopened, this has worked really well for me. Can I keep working from home? That's the sort of thing that's also happening in banks. You've got people at home who are like, this was great. I was more productive. I don't need to be in the office all the time. Maybe I come in two days a week and the other three days I work from home. That's the kind of thing where you can't just go back to your old processes. Part of the digital investments was to allow your employees to work from home and to work with their customers from home. That part is not going away. I think that, yes, there'll be some flavors of all three. Based on kind of where we are, I think the necessity of digital and digital now, not next quarter, but digital now is clear and your customers now expect it. They've seen it. They've seen that it works. They've seen you can pull it off. The regulators are okay with it. If you're not going to do it now, it's never going to happen. That's kind of where we're at.
Jim Young: All right. That'll do it for this week's show and Dallas, thanks again for coming on.
Dallas Wells: Thank you, Jim.
Jim Young: And the topic we talked in this one is one, brace yourself, you're going to hear more from us on this in the coming quarter. We're going to be asking that question, what's your next move, to bankers. Basically we'd like to hear what you have to say on that. You can respond to us via email. My email is firstname.lastname@example.org. That'll be in the show notes and via our social media platforms as well. Again, we'll be reaching out to you asking you that question. We'd love to hear what you have to say on that.
Thanks again for listening and for this usual few friendly reminders. If you want to listen to more of our podcast or check out more of our content, visit the resource page, precisionlender.com, or you can head over to our homepage to learn more about the company behind the content. If you like what you've been hearing, please leave us reviews on iTunes, Google Play, or Stitcher, love to get ratings and feedback on those platforms. Until next time, this is Jim Young and Dallas Wells, and you've been listening to the Purposeful Banker
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