Lessons From The 25 Year Flood

I kept referring to the unprecedented economic debacle the world is facing as the 100 year flood, until Russ Weyers, COO of Johnson Bank, accurately pointed out that we face something LIKE this (although not as severe) every 20-25 years or so.  We were at a CEO Forum discussing what we can learn from these crazy times and how can we take preventive measures going forward to avoid short memories and repeat performance…

Here are some of the group's insights.

1. Resist the temptation to make large loans relative to your capital position.  In fact, capping your loans at $10 million is a good idea to ensure risk diversification and improved core funding.
2. Stay in your markets.  Fishing in uncharted waters only increases the risk that you'll end up reeling in a shark in minnow's clothing…  Forays into new markets require strong local knowledge, especially when it comes to acquisitions of banks that were passed on by their local competitors.
3. Return to true commercial bankers vs. sales people/BDOs.  Many bemoan the loss of the credit-savvy commercial banker.  After years of no credit training by the megabanks and dummying down of their commercial sales force, it is left up to the SuperCommunity banks to fill in the vacuum by training their bankers to become true relationship managers and not just real estate elephant hunters.  Further, many commercial bankers never experienced a downturn, having lived through nearly 20 years of prosperity.  There is no better time to do so, as credit trainees can cut their teeth on difficult workout situations.
4. Review macro trends regularly to seek leading indicators and early warnings.  Many banks lack early warning "red flags" regarding their credit extension and portfolio holdings.  Establishing a set of such flags, coupled with strong concentration limits, will facilitate better REAL diversification in the future.
5. Guarantees and LTVs are valuable, but cash flow is KING.  Too many chief credit officers found too much comfort in saying, "At least we'll have the dirt".  Illiquid real estate does not reduce credit risk and losses; cash flow does.
6. Consider borrower's contingent liabilities in your underwriting.  Global cash flow is an asset to borrowers whose projects fall on hard times and fail to meet major milestones.  However, with the cash from other sources come liabilities that are not associated with the project, and both must be taken into consideration as loans are renegotiated and classified.
7. Beware of borrower's over-leverage and lavish lifestyle.  A ride in your client's Lamborghini is not a good sign…
8. Review incentive compensation with an eye toward risk and longer term view.  Your regulators certainly will do that in your next examination.  Adding risk mitigators, claw-backs and longer term vesting periods to incentive programs are all practices to be considered and employed as appropriate.
9. Establish concentration limits that are more granular and on commitments, not outstandings.  Commitments truly reflect the potential risk to the organization, vs. outstandings that reflect today's exposure only.
10. Don't rely on takeouts as your repayment strategy.  They present huge repayment risk.  This is more true today than ever before, since the take-out market has all but evaporated, with conduits out of the picture and insurance companies sitting on the sidelines.
11. Take more risk on borrowers who have a strong relationship with you and where you're the primary or only bank.  Those customers are far less likely to leave you in a lurch.  Going forward, emphasizing cross-selling in the true sense of the word to commercial customers will serve you well when the next crisis arrives.
12. Get into counter-cyclical businesses.  Many of our businesses are pro-cyclical.  Finding cycle mitigators such as mortgage originations and fee income generators is a legitimate risk reduction strategy.
13. Diversify revenue streams.  Most community banks are heavily margin-reliant.  Finding effective sources of fee income and additional product lines to capture clients' money as it moves from one form to another (deposits into investments, for example) is an important risk containment strategy.
14. Maintain good relationships with the regulators.  Regulators are people too… They appreciate respect, organization and coffee and doughnuts in the morning.  Treat them like any other Center of Influence, and they'll treat you better.  Also, they, like many others, hate surprises.  Full and early disclosure is appreciated.
15. Be ahead of the regulators in loan classifications, NPLs and charge-offs.  Dragging your feet will only cost you more in the long run.  Aggressively classify and write off your ailing credits, and your examiners will be less likely to push you further.
16. Separate workout from on-going lending activities.  Workouts are energy-sapping and often depressing.  You witness human betrayal, desperation and overall negativity.  It is extremely difficult to muster up the energy to call on prospects and clients when one spends most of their time chasing non-performing loans.  You'll be better served dedicated some of your bankers to the workout activities and free the most effective business developers to do what they do best: develop business.
17. Never forget liquidity.  We keep saying we want deposits, yet transfer pricing gives them miniscule credit in today's low rate environment.  What we say and what we pay incentives on are now often at odds, since many pay on profitability and loans in most TP systems are more profitable than deposits when rates are low.  Since banks fail often due to liquidity crises, you might consider adjusting the value you give to deposits to match the true value they create for shareholders:  not just current income and a replacement to wholesale funding, but also a relationship anchor; franchise value builder; capital creator; and stock price stabilizer.

I'm sure books can be written on what we've learned (and are still learning) from this environment.  Please share with me your own lessons; I'm here to learn.