While your bank’s main purpose is to help your customer achieve their dreams, one side business to that aspiration is that you manufacture credit. Credit does not magically appear, and like a manufacturer of widgets, a bank has a supply chain and process to put credit together. Luckily for us, it does not take tangible raw materials like steel and silicon chips, but it does take intangible raw materials in the form of intellectual property, hours of analysis, data and risk. That is a good thing as there is little friction in moving around intangible goods. However, there is a manufacturing process, and unfortunately, many banks are woefully inefficient at it. In this article (and companion webinar – registration at the bottom), we highlight those inefficiencies and give insight how a bank can become 20% or greater more efficient.
The Cost of Loan Manufacturing
Next, to your branch network, it is likely that loan manufacturing is your second largest functional cost at the bank. For many banks, it is the largest. Few processes within the bank eat up as many resources in the form of labor expense and capital. If you are working on improving performance, smart bankers focus on efficiency and loan processing as one of the best places to start.
A typical cost to manufacture commercial credit is between $4,000 and $15,000 depending on loan size and type, with $6,000 being a good proxy. This is in addition to sales and management costs and is just the incremental cost of analyzing, writing up credit, getting it approved and getting the loan booked. The ebb and flow of credit between months is amazingly similar among banks and follows something close to the below chart.
Banks typically have lulls in January and February and peaks at the end of each quarter. A bank’s typical high capacity point is usually in June where they process approximately 9.5% of their total loans for the year. Next to June, December is the second most common peak followed by September (these are all weighted averages above). Some of the production flow is driven by internal factors such as pressure to make quarter-end goals. Some loan production timing is driven by customers that need additional capital to make their quarter-end financial statements look better, and some of this flow is derived from the operational cadence of the market (loan brokers, real estate agents, etc. that all face the same quarter end pressure).
Similar to how you staff branches, bank management can create a more flexible loan operating system to smooth out some of these peaks and valleys. Just knowing the data above can allow your bank to not only better staff each position, but to conduct more accurate sales forecasting to improve on everything from earnings projections to how your sales people use their time.
For a typical bank, the peak to trough difference is usually about 3% of total annual production. Thus, if you book 1,000 loans per year, there is usually a 30 loan difference between “slow” and “busy” months. Most bank analysts can handle between five and six credits per month, so in our example, we are talking the difference in the labor of five or six full-time employees for every 1,000 loans of annual production. By smoothing the production schedule out, that equates to two or three employees that can be tasked doing other assignments. If you produce 1,000 loans per year, you likely have a staff of 15 analysts, so two or three more productive FTEs is like saving 15% to 20% of costs.
The Most Common Problem
If you break down loan production into new and renewal loans, you will immediately see an issue. Below is the composite data from the above chart.
Since most banks tend to set maturities in the form of even years, it is no surprise that loans also come up for renewals during the peak loan production times – usually at the end of each quarter. In the same fashion, most banks also tend to review credit during anniversaries, so each end of the quarter also happens to be heavy for annual reviews. Add all this up, and it turns out that your bank is likely at full capacity (and stress) at each end of the calendar quarter. We will also quickly add that this manufacturing problem puts related stress on loan operations, finance, risk and management.
Making This Look Different
The easiest thing to first shift is credit reviews. Since these are not hyper-time sensitive, these can be shifted to off cycle times. Many banks have already done this to line up with financial statement generation that tends to fall on the month after quarter-end. This is a start, but more can be done by triaging credit and shifting the lower risk credit out longer to slow months such as January and February. In addition, some banks, like us, have gone to a longer-than-annual review cycle depending on scored credit quality. This dramatically reduces the workload and allows analysts to better schedule “credit maintenance” times.
Shifting renewals can also have a major impact. Banks can either set their renewals early (some as much as 13 months ahead of maturity) or shift their term sheet protocols so that maturities are slightly more than a year and are set based on sequencing of document preparation (or term sheet production, etc.). For example, the first loan booked for the month matures on the anniversary, while two extra months are added to the maturity of the next loan. Thus, if you make a ten-year loan in December, the maturity would technically be ten years and two months allowing for the renewal to roll to January.
The good news is that manufacturing credit is infinitely easier than manufacturing widgets. The just-in-time nature of credit production and intangible aspects give banks a huge advantage compared to other industries. Unfortunately, without seeing the raw materials on loading docks and in purchase orders, bankers get lost in truly understanding their cost of production and logistical metrics. This is a shame as if we did, obvious problems like stacking new loans, renewals and reviews all in the same month would come to light easier. Automated lending platforms can get you to a 15% efficiency ratio. While you may not be able to get to that level with your current process, hopefully by employing some of these ideas, you can get into the 50% range.
The above is just one simple facet of a more complex, multi-echelon credit production problem. The reality is that banks can improve efficiencies in many different areas such as appraisal ordering, loan process workflow, quality/risk review of underwriting, loan committee approval scheduling and similar. Here at CenterState, we are in the process of completely reorganizing our credit manufacturing efforts and have rolled our first phase into production. Keep in mind that this effort does more than cut costs, as it also speeds up decisions for the customer, while also helping free up lenders and business development officers to make better use of their time.
Free Webinar On This Topic
In the coming weeks, look for more focus on this area as we detail or lessons and challenges. In June, we will be holding a free webinar that covers the entire process and gives bankers real time updates of our cost and time saves. To sign up, go HERE to register.
Submitted by Chris Nichols on May 04, 2017