Aligning ALCO with Loan Pricing [Podcast]

Helpful Links

• Darling Consulting Group
• DCG Annual Balance Sheet Management Conference
• Financial Managers Society

LinkedIn Groups:

• Asset & Liability Management Practitioners
• Asset Liability Management (ALM)
• Bank Treasury and Financial Risk Management
• Interest Rate Risk Management Group
• ALM – Banking Business

Podcast Transcript

Hi and welcome to lender performance, your guide to becoming a better lender. Dallas and Jess here from Precision Lender, thank you for joining us. The theme of today’s episode is how to align your bank’s ALCO with loan pricing. We’re going to talk with Darnell Canada who is a managing director at Darling Consulting Group, one of the nations premier ALM solution providers for community banks.

Darling Consulting Group which is based out of my home state of Massachusetts, was named one of the top places to work for in 2015 by the Boston Globe. Darnell started his career as a bank examiner with the FDIC and has been with Darling Consulting Group for the past 20 years. Darnell thank you for being with us here today.

Thank you.

Darnell, thanks again for taking the time and would just starting by telling us a little bit about yourself and how you landed at Darling and some of your responsibilities there.

It wasn’t actually a very long road it was pretty quick in my professional development, I started out on the regulatory side as Jessica had suggested up in the Boston region for the FDIC and after a couple years of exposure to banks during the tail end of the last mortgage crisis I made the decision to venture out and sort of expand my wings a little bit. At the time Darling Consulting Group was a small asset liability management firm just getting it’s feet on the ground and starting to develop a real following in terms of it’s expertise and skillset and so forth. I was fortunately one of the early members in the firm.

Okay great and can you tell us a little bit more about Darling Consulting Group and what specifically you guys do.

Absolutely, we’re an independent solutions firm that partners with and advises over roughly 650 financial institutions across the country, we specialize in the area of asset liability management and I like to put a bit of a definition on it in terms of just managing financial risks. I say that because sometimes asset liability management is confused with just simply interest rate risk management and what we do spans a much broader spectrum than that. Our clients span across all of the regulatory charters, FDIC, OCC, the Fed, the NCOA and they range from very small institutions to some of the largest institutions in the country.

Half of those institutions actively involve us in their quarterly ALCO process and decision making, they look to us to help them really maximize their profit given whatever their set of risk tolerances are and the other half leverage our expertise in broad exposure for a variety of model validation type projects.

Okay, great. I said it one, you said it once for anybody who’s not familiar would you mind helping us kind of give a high level definition of what ALCO is and what that committee really does?

ALCO to us is really a central cog for decision making within the banking institution, and I say that because for any business decisions really need to be made in the context of what kind of risk exposures you have, what kind of opportunities exist in the marketplace and so forth. ALCO for a bank or credit union is the one area within the organization that brings in all facets of the business, from the lending department to the deposit gathering and acquisition area to the treasury management function and within that forum. Successful organizations anyway will discuss what their overall risk profile looks like and what I mean by that is not just simply interest rate risk as I said before, but looking at liquidity exposures, looking at capital and credit. What are all the financial risks in isolation and what will determine FILO’s but also how do they all need to relate with one another.

Based upon what that picture looks like then we can talk about, well how does this affect the loan portfolio and what the folks in that area are trying to do and how does this affect what we’re trying to accomplish on the deposit and funding side of the balance sheet. Depending on what’s happening on our core balance sheet, then we can talk about, okay what are our needs from a treasury management standpoint.

Yes and so having sat in on a lot of ALCO meetings, I’ve seen those range as I’m sure you have, from the ones that are very much just checking the box and saying we have to do this because regulators required it of us and the examiners are going to ask for it. Then those that do a really good job of it, of making that committee really the central strategy hub of the bank and really manage the overall balance sheet.

Absolutely, it’s been a long evolution for the industry and I say that, when I started with DCG back in the early 90s, asset liability management was in our minds was really still in it’s infancy in terms of how banks and credit unions were looking at it. It was in fact just a list of check box items that really was nothing, and the ALCO function was really nothing more than a cost center and by what we identified and what we’ve tried espouse with our clients is, this is a lot bigger a lot more important than just satisfying the needs of the stipulations from a regulatory standpoint. This is where you can make the most of your balance sheet in terms of driving performance. More and more institutions over the course of time and the regulators since. I’d say in this really accelerated after the ’08 crisis really made this transition to say, okay these institutions can’t just be looking at models and the outputs of these models to just understand what a picture looks like, there’s got to be a connection.

That connection has to say, okay what does our picture, our profile look like, do we like it, do we dislike it. How does it fit with what we’re trying to achieve and then how does that then therefore affect our decisions going forward.

As banks have gotten more complex, I think we’ve seen a lot of the silo effect. Where the loan group handles their own thing and the treasury group handles the stuff they manage and the deposit group, etc. I think that’s why we’ve seen so much focus from the regulators lately on this group because it’s the one place where those silos should come together and as you say, we make those connected decision of how all the pieces of the balance sheet work together from performance and risk perspectives.

Absolutely.

With that increased focus of the last couple years and the regulators have been pretty clear about, how ALCO and interest rate risk and the enterprise level of risk management, they’ve made that very much a focal point. Have you noticed a change in actual “on the ground” expectations for your clients and if so what are the specific things they’re being asked to do now that they weren’t asked to do before?

Since the ’08 crisis we’ve about as great a transition or an acceleration and increase in expectation for banks than we’ve seen in 20 some odd years. It’s no longer sufficient to look at small set of scenarios or look at one single isolated kind of analysis because, as well all know, with any kind of financial risk modeling there is a wide array of scenarios that can play out. What tends to happen is that we pick a set of comfortable or normal scenarios and based upon those normal scenarios we might come to some conclusions as to what kinds of things make most sense for our balance sheet. Well what the reality is and what we learned in 2008, was that if things remain static for long enough, what becomes normal and the variety of kinds of scenarios that fall under the spectrum of “normal” starts to become more and more narrow. What that does is it begins to dilute our ability to identify what risks can actually do to our balance sheet, or how risk can actually metamorphosize our balance sheet.

If things become a little bit outside the norm they can have a material impact on our performance. Banks and credit unions now are saddled with analyzing data and analyzing a much greater number of scenarios and while this places a pretty good deal of burden and cost into the ALCO function, the C-suite executives really need to start to understand that this is all for the betterment of the institution. Again, it’s not, it shouldn’t be viewed as a cost center, it shouldn’t be viewed as just another item we have to do because the regulators have nothing better to ask of us. It really does tie into how effectively we are able to manage our balance sheet. Taking that information, using that information in terms of whether we want to do fixed rate lending or how much we should be forgoing fixed rate lending as an example.

The other part of it is the level of education within the organization and the expectation there. Banks and credit unions are expected to have a much deeper bench in terms of who knows what’s going on within the ALCO function and who understands the details of that process.

Yes, absolutely.

From staff up to the board level.

Right, even outside directors being asked some fairly technical questions, I think that part we’re trying to bridge the gap a little bit is production staff. Lenders specifically and how the decision they’re making and the discussions they’re having with borrowers. How that’s helping shape what that balance sheet looks like and kind of connect the dots for them.

Absolutely.

To that end, what we’ve seen in a lot of institutions is, even though loans typically make up the biggest share of the asset base, a lot of times they get a very small share of the out go agenda, they don’t get a lot of time with that group. That time tends to be dominated by discussions about funding strategies or what we’re doing with the bond portfolio. What do you think, why do you think that is? What causes that kind of disconnect there between impact on performance versus how much time we spend talking about it with that group?

I think the unfortunate reality is, and particularly in this kind of environment right now. Where the economy is not as strong and we’re not seeing the level of demand driven growth that we’d like to see as an industry. I think part of that is that banks and credit unions almost feel at the will of the borrower. And competition is so strong right now that many institutions feel that if they don’t do what the borrower is asking of them then they’re not going to win the deals. They’re not going to grow their business and therefore they’re not going to succeed in terms of growth and that I think is a valid concern. But also a very large conundrum, because the types of lending that banks and credit unions do really have to fit within the context of how they’re trying to structure the balance sheet. It’s how do we balance out offering the borrower, or trying to get a balance of what the borrower is looking for and what’s good for our balance sheet as an institution.

Yes, so what are some things that you all suggest when you come across that issue, to help banks and credit unions better incorporate the loan portfolio into that ALCO strategy and better connect those two things?

That is a very complicated or complex question, in it’s simplicity. I would suggest that, first and foremost, there has to be a dedicated effort to educate the staff. I think you said it when you suggested that banks and credit unions need to bring in their lending staff to understand what asset liability management is. What we’re seeing is that with a lot of our clients, we’re suggesting and we’re seeing them do for themselves in many cases, is bring in lending staff in particular to understand and to hear the kind of conversations that we’re having. It is or it isn’t a good idea for us to put on fixed rate loans, it is or it isn’t a good idea to originate and hold residential mortgages versus commercial real estate mortgages versus construction and development mortgages.

A five year loan might be acceptable where a seven year loan isn’t, why is that? I think the other bigger strategic issue that banks need to really think about is the manner in which they’re developing the sales culture within the lending function. What I mean by that is, all to often and again I think part of it’s the function of the environment that we’re in and part of it is that it’s a difficult endeavor for any business never mind banking. But the banks that we see grow most successfully in volume and in spread and profit margin and in profitability and also in structure, are the banks that really have a dedicated sales culture. They have people that are out beating the streets developing business. But they’re doing so in a calculated and deliberate fashion. So they’re looking at and trying to understand what is the kind of business that I’m looking for. All business, all customers, all borrowers are not the same and some are consistent with my business strategy and some aren’t, and they may sometimes fit within the same loan classification or loan category.

When is it that we should be willing and able to say no to a borrower? What are the conditions under which a borrower is not a fit for our bank? A lot of banks suggest that they’re looking to build relationships but, what ends up happening is they end up executing on a lot of transactions and the relationships pass them by. From that standpoint, how do I look at not only generating new business but how do I retain the business that I am generating. In other words, what are the needs and circumstances of the borrower that are going to make them want to do business with me on an ongoing basis. What that does, is that helps that bank understand how to acquire new business but also, how to mitigate run off and so, one of the bigger things that’s starting to evolve right now since this rate movement is a pretty significant shift in the shape of the yield curve.

Prepayment activity is again becoming a more frequent conversations that we’re having with clients and those that are at the greatest risk of exposure are the ones that haven’t established that relationship framework. Because the client is going to put them out to bid and look at them as more of a commodity as opposed to a business relationship, where they have a certain need and they then look to the bank to say, okay, how can we work together to satisfy the need that I have right now.

Yes, I love that approach of taking ALCO from not just talking about model results and getting way off into the weeds on specific assumptions and where those fall within policy. But really making that conversation more about that strategy, not just what assets would we like to have on the books but how do we actually go about executing and getting those things on the books. That’s going to ultimately come down to things like strategy and pricing and marketing. Really big picture stuff that a lot of times banks don’t want to talk about that at the ALCO level but that’s really where that conversation needs to start.

Absolutely, ALCO in it’s simplest form, the ALCO processes is nothing more than the tactical mechanism that allows the bank to execute on it’s longer term strategic plan. So within that framework, the bank needs to really understand and the staff, the business development staff needs to really understand what’s the value proposition of the institution. How do they develop a message that carries out to the marketplace that then allows them to do the things that they’re trying to do because you establish a paradigm shift from being a solutions provider to the clients that they’re looking to attain. As opposed to being a source for the lowest cost pricing that the customer would like to have.

Yes, we talked a little bit about the importance of ALCO and how it needs to connect to really that front line production stuff. We’ll wrap up with one last question here, which is, when lenders or anybody in the bank really, if they want to go and learn more about ALCO and that function and how it fits in the bank and how it works. What are some resources that you would suggest, where can they go to find information and learn more?

Well first I would say sign up for the June 6th and 7th DCG conference.

Okay, I like the plug.

That happens every first Monday and Tuesday in June of every year, but there’s a wealth of periodicals and materials out there. I think what we find with our clients is that they take an active role in trying to seek out conferences and banking groups that help sort of cross pollinate information, strategy, education in terms of industry developments. There’s financial risk management groups, there are bank to yield networks and things like that. That your C-suite executives can participate in, but from a board standpoint, from a staffing level standpoint it sometimes can appear to be expensive to send them to a conference but when you start to think about and ask yourself, what did they get out of that conference. Provided that they’re actually there to learn something and to the extent that they can translate that new knowledge into more executable strategies. That investment in staff and personnel pays itself several times over.

Yes absolutely. Well, we’re big believers in that as well, in fact we’ll be at your conference June 6 and 7 so we’ll put some links with the show notes for this episode. We’ll put some links to that stuff out there and also to your guys’ website which has another good resources. There’s a couple LinkedIn groups that are also good, so we’ll put some links to all that stuff out there. If anyone has some other ones that they think are useful please throw those in the comments when this goes live. That’ll do it for us today, thanks for listening and Darnell thanks for joining us.

Thank you Dallas and thanks Jessica, it was my pleasure to be involved. Thank you very much.

You bet, thank you, you can find more information about today’s episode and about Darling Consulting Group at precisionlender.com/podcast. If you like what you’ve been hearing make sure to subscribe to the feed in iTunes, SoundCloud or Stitcher and we’d love to get feedback and ratings on any of those platforms. Thanks for listening, until next time I’m Dallas Wells..

and I’m Jessica Stone…

and I’m Darnell Canada.

and this Lender Performance.