Commercial Lending: The Evolving Relationship Manager Model

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1 Commercial Lending: The Evolving Relationship Manager Model John A. O Connor Marc Carbonetta BenchMark Consulting International History The role of the loan officer in commercial lending, often referred to as the relationship manager, remained relatively unchanged until the last decade. The relationship manager was typically a very seasoned lender having ascended to the role only after apprenticing in junior lending positions for several years. The junior positions provided the training ground for fundamentals including financial statement spreading, trend analysis, industry analysis, loan structure, credit approval writing and sales training. One proved themselves over time, eventually growing and managing their own portfolio of larger and more complex credits. Commercial lenders often resided in larger bank branches where a host of lenders sat at desks on the platform side of the branch. In some cases they could be found in regional offices. It was not unusual to find bankers linked to the same office for 15 years or longer developing their skills and growing a portfolio. Relationship managers were seen as experts in the area of financial advisement by clients. They provided financial guidance and a single point of contact for the client. Loans were customized to meet the needs of each business. Products were basic: lines of credit and term loans with some specialty products to meet specific business or industry needs. However, there were many variations of the two basic products. Generally, loan terms (structure) including use of covenants, together with pricing were mixed and matched yielding multiple and unique credit solutions. Relationship managers only called in supporting bank groups when additional services outside of their expertise, such as cash management or trust services, were warranted. The entire credit process was very manual. Financial statement spreading was often performed by the relationship manager. The credit write-up and detailing relationship profitability was also the domain of the relationship manager. Credit write-ups were comprehensive with little variation between the initial write-up and subsequent reviews or renewals, even for low risk performing clients. There was modest reliance upon supporting personnel. Completed write-ups were personally moved along in either one-over-one credit approvals with face-to-face discussions at each level, or through a regularly occurring loan committee procedure meeting. The process took time and both clients and the bank accepted the nature of the decision process. Another hallmark of the traditional relationship manager was time spent with the client. Beyond the initial meeting and loan negotiation, relationship managers periodically visited the client s business site. They looked to bond with the client emphasizing the single point of contact, reduce potential encroachment by financial competitors, and review business operations for opportunities and credit risk. Site visits and entertaining clients at lunch or a ballgame was expected. Sales and loan growth were always an integral part of commercial lending. Banks were selective in the credit profile of prospects they solicited. Loan growth was more long term, allowing the relationship manager to steadily grow the portfolio while simultaneously performing all portfolio maintenance activities. In other words, the relationship manager was a generalist responsible for all aspects of lending. The generalist or traditional relationship manager still exists in 2007 BenchMark Consulting International, N.A., Inc. All Rights Reserved.

2 many organizations. However, the need for organizations to more effectively generate growth, advances in technology, an increasing emphasis on portfolio quality, and erosion of credit skilled lenders has moved many organizations to re-think the traditional relationship manager model. A model that separates sales and credit decisioning activities & leverages personnel skills is gaining momentum. A New Way of Thinking Credit Scoring Commercial lending and Consumer (or personal) lending were viewed as two very different disciplines. Since the early 1960s, Consumer lending had begun to apply financial performance statistics to arrive at credit decisions. Personal credit history habits and trends were analyzed and a credit score was developed. The score (ex: Beacon or FICO) was and is very predictive in setting default expectations. By utilizing a score based upon proven statistical elements, Consumer purpose loans could be decisioned quickly with minimal supporting financial information. The decisions were/are more objective leading to consistency in credit granted and performance desired. However, that score was limited to individual performance and only used on personal or consumer purpose loans. Fast forward to the early 1990s. The financial industry began to look at the smaller commercial loans in the portfolio. Lenders desired a more efficient and effective method for processing the smaller credits. These small credits traditionally required the same process for an initial decision and subsequent reviews as much larger credits. Typically, the only difference between the two was a few pages of write-up and fewer rungs of credit approval. The cost of putting these small credits on the books and maintaining them was prohibitive. Many smaller credits rely upon the owners as much as business performance for repayment. Often, the two are intertwined. A new model was developed that incorporated the owner s (personal) bureau score, business bureau scores and financial statement attributes yielding a business score. The model was initially valid on loans of less than $50,000 made to a business with annual sales of less than $1MM. For many banks, this population of credits represented a large portion of Commercial loan units and enabled this segment to become a profitable and growing core of business. Lenders soon segmented the small dollar portion of the Commercial portfolio with its hybrid decisioning methodology. Many named the segment Business Banking or Small Business Lending (note: not the same definition as used by the Small Business Lending Administration). The remaining (larger exposure dollar) Commercial portfolio segment is often referred to as Middle Market or simply the Commercial Group. Banks increased their definitions of Business Banking as credits seasoned and performance was validated. Over time, statistical performance became available on larger credits and vendors offered more robust score cards. Lenders began to combine scoring with financial statement analysis-streamlining the decision process for ever-larger credits. For many institutions, the definition of Business Banking now includes companies with sales at or above $10MM and credit exposure in excess of $3MM. Under that definition, institutions are decisioning upwards of 75% of all commercial units under their Business Banking model. Separating Selling from Decisioning Credit scoring provided a discipline and consistency in decisioning credits. To leverage the scoring process, credit products were refined; more clearly defined; and matched to this segment. Products were broad enough to meet the needs of targeted businesses, yet were limited in terms and pricing variables. Selling to-and solving for-a business needs was now easier for loan officers. With defined products and specific underwriting criteria, suddenly science had invaded the territory previously reserved exclusively for the art of lending. One attribute of credit scoring was the realization decisioning was not dependent upon meeting with the client. Scoring could be performed regionally or centrally. Business Bankers no longer needed to be generalists. Field loan officers or relationship managers could now concentrate on selling and retention activities. Relationship managers could be effective with a modicum of credit skills (as the crux of credit decisioning is performed by dedicated regional or central BenchMark Consulting International 2 Evolving Relationship Manager Model January 2007

3 underwriters). The division of sales and credit responsibilities leveraged personnel through alignment of roles and incentives to drive performance. It also enabled less traditionally seasoned loan officers to effectively market small commercial loan products and services. Banks began to integrate their retail branch personnel into selling small business products, leveraging a low cost origination channel. Portfolio management also benefited from scoring. Loan portfolios could be systematically reviewed multiple times during the year. High risk profile credits were identified; proactively improving credit quality while reducing personnel costs to support these maintenance activities. Training The path to becoming a Middle Market commercial lending officer was altered. Many traditional relationship managers with solid credit skills were converted to Business Banking underwriters. Middle Market could no longer nurture loan officers through years of apprenticing on ever larger credits. Further, Middle Market and Business Banking are often managed separately minimizing personnel transition between the two. The increase in definition of a Business Banking client over the years has raised the definition of Middle Market. Middle Market relationship managers must possess well-developed skill sets to market and structure large and complex credits. Long ago, most organizations abandoned formal credit training, necessitating the need to buy those skills by luring seasoned lenders away from competitor organizations. Lenders with skills to both market larger, more complex credits as well as structure and present them has dwindled. Many possess accomplished skills in only one of the two disciplines necessary to be an effective generalist or traditional lender. Current Factors Credit Quality Although financial institutions have always focused on credit quality, today there is a greater emphasis. Bank Examiners are looking for adequate processes to support timely recognition of increased credit risk in addition to correctly identifying the initial risk in any single credit. What is driving the emphasis on timely risk reporting? Most likely Basel II. Federal Reserve Chairman Ben S. Bernanke, on the definition of Basel II, sums it up best, Both robust risk management and strong capital positions are critical to ensure that individual banking organizations operate in a safe and sound manner that enhances the stability of the financial system. 1 Credit risk is one of the three major components used to calculate overall bank risk. Setting expected loss rates requires frequent and meaningful assessments of portfolio risk. In Middle Market, quarterly reviews of credits requires updated financial statements, trend analysis, updating economic risk and written support of the credit assessment. Less than satisfactory risk rated credits may require even more frequent reporting. Although these activities may be necessary to continuously set capital requirements, they absorb relationship manager time. Risk vs. Reward A bank s appetite for credit risk and the management of that risk will drive policy, which in turn drives process. Credit policies are generally born or modified based on interpretation of Federal requirements as well as past institutional credit experience. That is why two banks with similar risk appetites can possess dissimilar credit policies. Middle Market credit policies generally mandate, at minimum, quarterly reviews of lines of credit and periodic reviews of term credits. However, the requirements governing the format, length, and depth of interim and annual reviews vary widely by institution. Relationship managers burdened with expansive, full write-ups and personal credit presentations see as much as 80% of their time taken up in maintenance activities. This leaves little time for sales and retention activities. Banks have not lowered sales growth expectations - even in light of increased portfolio reporting activities. Many still look to double-digit growth, citing a strong economy and business recovery since Lenders are increasingly competing 1 Bernanke, Ben S. Modern Risk Management and Banking Supervision. Stonier Graduate School of Banking. Washington, D.C. 12 June BenchMark Consulting International 3 Evolving Relationship Manager Model January 2007

4 with non-traditional financing sources as well as traditional banks. For many institutions, Middle Market growth has been flat. Most growth has taken place in Business Banking. The larger, more profitable credit relationships desired in Middle Market are chased by many and conversion often takes months or years. Traditional relationship managers are stretched to find marketing time. This impacts institutional goals as relationship managers often settle for smaller companies as they are easier to find, convert, and decision. While most banks possess pricing models intended to ensure profitable relationships, many choose to waive exceptions to pricing standards in order to gain business. BenchMark frequently observes Middle Market portfolios that have a decidedly Business Banking look as defined by that organization. While Middle Market management acknowledges the issue, growth goals demand results. Incentive to Change With Middle Market growth relatively flat for the industry and increasing focus on credit quality, institutions have come under mounting pressure to maximize resources. Becoming efficient is relatively new to Middle Market. Ownership of the largest dollar portfolio in most banks has allowed management to avoid changes to their successful segment. In the traditional model, lenders are finding it difficult to be all things to all people. They are falling short in either sales or portfolio management activities or both. Moreover, customers now have more options and want better service. They have been conditioned to expect fast turn around on credit decisions and reduced paperwork. Clients want to be bothered less by financial reporting requirements, especially when they have performed for many years. Many banks have chosen to borrow fundamental attributes of the Business Banking model to improve Middle Market effectiveness. Most notably, they have leveraged the bifurcation of the traditional relationship manager tasks. Segregating the sales and retention activities from portfolio activities provides the capacity lacking in the traditional model. The bifurcated model also enables scalability to further leverage personnel and reduce future personnel expenditures. What Middle Market Learned from Business Banking Business Banking first and foremost demonstrated that specialization works in the commercial segment. Business Banking relationship managers successfully manage more relationships than before and possess the capacity to grow their business. Credit performance of the Business Banking portfolio is stronger due to dedicated credit underwriters and portfolio managers. The roles and priorities of both relationship managers and back office credit personnel is clear, allowing each to focus on their primary responsibilities. Products are well defined and matched to underwriting and portfolio management policies. There is minimal customization on the bulk of credits. Quick decisions equate to a profitable product. Minimal customization directly correlates to a significant reduction, and in many institutions, elimination of loan covenants on all but a few of the largest credits. When covenants are used, there are a select few consisting of standard language approved by Credit. The defined products and minimal covenants aid in document preparation by enabling use of standard and streamlined forms. Middle Market, on the other hand, often deals with more sophisticated borrowers and more complex lending solutions. However, many in Middle Market have discovered there is room for streamlining the process and some standardization, especially in loan covenants. Banks have found they routinely encourage customization in covenants - believing they must create a unique solution for each client. When queried, most line officers and credit administration officers see a need for relatively few covenants. Reducing the options does not mean customer needs are not met or credit quality is compromised. Through standardization, credits can be more efficiently written, presented, and approved. The added benefit is streamlining. Simplification improves subsequent reviews and renewals as well as personnel capacity. Business Banking also demonstrated that streamlined processing does not have to mean increased credit risk. Credit policies and processes matched to risk enable personnel to BenchMark Consulting International 4 Evolving Relationship Manager Model January 2007

5 focus on credits exhibiting the greatest risk potential. Where Middle Market Differs from Business Banking In Middle Market, there will naturally be more customization than in Business Banking. This segment often requires unique solutions to client needs. A balance must be struck between 100% customization and defined product sets that allow for no flexibility. Unlike Business Banking, a strict separation between front and back office personnel does not represent the most effective delivery model. Due to borrower sophistication and credit size, there will be occasions when Relationship Managers (sales and retention / field) work closely with Portfolio Managers (underwriting and portfolio maintenance / back or middle office) both in the field and in the office. There is more interplay and balance between the two positions in Middle Market. Execution is Key In the most successful Middle Market bifurcated models, relationship managers and portfolio managers are often teamed. Portfolio Managers typically support a discreet few Relationship Managers. They must work as a team to effectively process credit. Matching the appropriate skill sets to each position is one key to a successful model. Each should possess some of the other s skills, i.e. Relationship Managers need credit skills while Portfolio Managers need sales and customer service skills. Another key to success is dependent upon the awareness that the positions are equal even while focused on different aspects of the credit process. When the model fails or is inefficient, it is generally due to unequal skill sets or unequal management of the two positions. The third key to success is the credit hand-off. Relationship Managers need to deliver a credit package with sufficient clarity so the Portfolio Manager is able to build out the credit; yet not so detailed that the Relationship Manager becomes the de-facto underwriter. Portfolio Managers must know when to involve Relationship Managers in the review and renewal process. There is no hard set of rules for handoffs as credit and client relationship nuances will drive the process. Common sense and an institution s guidance regarding separation of duties generally dictate the best course of action. When successfully executed, not only does the bifurcated model improve capacity in personnel, it also helps solve for another issue resident with the traditional model. In the traditional model, the Relationship Manager is the primary contact for the client. The client perceives the Relationship Manager as the bank. While that has its advantage from a customer loyalty perspective, it has the disadvantage of working against the bank when an officer leaves for a competitor. They tend to take clients with them as the officer is generally the only voice the client knows. In the bifurcated model, the client is introduced to the Portfolio Manager who becomes, in effect, the secondary relationship officer. Flight risk is reduced. A byproduct is the client actually receives better customer service. The Portfolio Manager is typically more accessible than the Relationship Manager with direct contact to service personnel. Banks that stress relationship lending actually demonstrate their motto by providing clients with more contacts and servicing options. Improved Credit Quality As noted earlier, banks are emphasizing credit quality more than ever. Portfolio Managers have primary responsibility for periodic reviews and credit presentations. This singular focus places them in the best position to thoroughly review credits. In the traditional model, the Relationship Manager often performed only cursory reviews due to sales pressure and time constraints. In the bifurcated model the Relationship Manager retains primary responsibility for site visits and client interaction. They are in the best position for noting changes in management, operations, the business climate, as well as potential borrowing needs. When executed correctly, this model brings two sets of eyes and experience to bear on each credit. Typically, annual reviews and renewals are completed more timely. Interim reviews are more thorough. Credits that deteriorate below satisfactory require more frequent reporting as well as a workout plan and review for adherence to the plan. The Portfolio Manager assumes primary responsibility for these activities allowing BenchMark Consulting International 5 Evolving Relationship Manager Model January 2007

6 the Relationship Manager to continue focusing on sales and customer retention activities. In the bifurcated model, financial spreading is often prepared by specialists. Spreads are available, on line, reducing the need to move paper to drive the process. These financial statement specialists track for financial statements, spread business and personal statements, test covenants and alert line officers to violations and potential credit deterioration. The bifurcated model is maximized when administrative tasks are performed by supporting personnel. This further frees the Relationship Manager and Portfolio Manager to focus on primary tasks. Institutional Benefit In the traditional model, rarely are Relationship Managers highly skilled in all aspects of the credit process. Mismatched or underdeveloped skills results in decision delays and/or increased portfolio risk. Segregation of the two fundamental activities of a Middle Market lending officer sales growth and portfolio quality improves the effectiveness of the associated personnel. Relationship Managers gain a large portion of their day back through relief of portfolio tasks. The bank is able to leverage this capacity with increased sales expectations and portfolio growth without the expense of hiring additional Relationship Managers. Portfolio Managers gain efficiencies from singular focus and delegation of administrative tasks. Capacity is improved because personnel expertise is aligned with institutional objectives. Overall, banks benefit on many levels when the bifurcated model is successfully executed. John O Connor is the Commercial Lending Practice Manager responsible for the sale and delivery of commercial banking engagements. He holds extensive experience in commercial banking management, reengineering and streamlining operations, product and project management, mergers and solidations. Marc Carbonetta is a financial service professional with twenty-five years of experience in commercial, small business, and regional and retail banking. He has a comprehensive background in lending with emphasis in credit structuring, credit review, commercial lease finance, private banking, project management and training. He has demonstrated expertise in identifying process improvement and savings opportunities through business process assessment, design, and change implementation. BenchMark Consulting International has specialized in improving the financial services industry since The company is a management consulting firm that improves the profitability of its financial services customers through the delivery of management decision-making information and change management services to realize the benefits of business process changes. BenchMark Consulting International s expertise is in the measuring, designing, and managing of operational processes. The firm has worked with 38 of the top 50 (in asset size) commercial banks, all 14 automobile captive finance corporations, several of the largest consumer finance corporations and many regional and community banks throughout the United States. Internationally, BenchMark Consulting International has worked with the five largest Canadian commercial banks, more than 40 European organizations in 11 different countries, in addition to financial institutions in Latin America, Australia and Asia. The company is a wholly owned subsidiary of Fidelity National Information Services, Inc., with clients in more than 50 countries and territories, providing application software, information processing management, outsourcing services and professional IT consulting to the financial services and mortgage industries. BenchMark Consulting International has dual headquarters in Atlanta, Georgia and Munich, Germany. For more information please visit BenchMark Consulting International 14 Piedmont Center NE, Suite 950 Atlanta, GA (404)