Avoiding Frankenstein-ing Your Work

You are sitting in your office studying your bank’s third quarter financial statements and reports. frankWHAT the heck happened?  That empty feeling hits deep in the bottom of your stomach and indigestion sets in!  You are well below budget or vastly exceeded your budget. Past dues are higher over the past six months and your investment portfolio didn’t quite perform as well as you thought.  The loan renewals are coming in with tighter debt coverage ratios. It appears your customers’ margins are getting squeezed.  Dang, the bank’s margins are compressing due to rising rates in your deposits.

Now you need to start your budgeting process with your management team and it appears your team will need to budget down for 2019. You also have the responsibility to inform the board the bank isn’t going to make the budget.  WOW!  Maybe you feel the need to make some calls to your largest shareholders and let them know the bad news.  Dang, the annual shareholders meeting is going to be intense.  2019 sure is going to be a tough year because the Fed keeps raising rates.  The next exam is going to be tough!  The economy is very good, but my bank is experiencing things it shouldn’t be.  ALSO, this CECL thing!  WHY!

WRONG!  This is your story!  REALITY:  It’s the direct result of your systems + processes + disciplines.  It’s the outcome you were going to receive because actions and focus were not on your systems + process + discipline.  You reached a little here and a little there.  The creep set in, and because creep is slow, you didn’t recognize it.  Most likely you didn’t remember the OUTCOMES you were trying to achieve.  You didn’t ADAPT.

But now you get the opportunity to react. Reaction takes much more ENERGY, RESOURCES, CAPITAL, and STRESS.  MCSWAIN CONSULTING takes a deep dive into your systems + process + disciplines through our proven methods.  We will identify weaknesses so that you can be proactive.  We will get you the information to avoid major mistakes.

Three things you should benchmark:

1)Loan Growth Rate v Capital Growth Rate

2) Past Dues, TDR’s and Non-Performing Loans

3) Net Interest Margin

MCSWAIN CONSULTING can help.  We offer Loan Reviews, CRE-Stress Testing, System and Process Reviews, ALLL Reviews and General Consulting!  Our team of consultants has over 145 years of combined banking, consulting and business experience.  We have seen many different business cycles going back to the 1980s.  Contact us today to discuss a REALIGNMENT for 2019.

 

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You Should Read This: Bank 3.0 by Brett King

41AzJecTO+LAs I’ve written about here in my personal journey through banking from my childhood in the 70’s to present day, banking has done more than “change” or “evolve” – it’s practically morphed from a noun to a verb. As Brett King says in his book, Bank 3.0, banking is quickly becoming something we “do” not somewhere we go.
From online transactions to apps to stand-alone ATMs, the days of standing in line and getting a sucker or gum at the counter are becoming a thing of the past. My role as a banking consultant is to look for what’s ahead to help prepare banks for success, not just survival.
Find out more about Bank 3.0 here. 
From the Publisher:
In BANK 3.0, Brett King brings the story up to date with the latest trends redefining financial services and payments—from the global scramble for dominance of the mobile wallet and the expectations created by tablet computing to the operationalising of the cloud, the explosion of social media, and the rise of the de-banked consumer, who doesn’t need a bank at all.
BANK 3.0 shows that the gap between customers and financial services players is rapidly widening, leaving massive opportunities for new, non-bank competitors to totally disrupt the industry.
“On the Web and on Mobile, the customer isn’t king—he’s dictator. Highly impatient, skeptical, cynical. Brett King understands deeply what drives this new hard-nosed customer. Banking professionals would do well to heed his advice.”
Gerry McGovern, author of Killer Web Content
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David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, loan reviews, and bank consulting services to community banks in Oklahoma, Texas, and Kansas. 

The Road Less Stupid as it Relates to Loans, Loan Review, Annual Reviews and Credit Analysis

51zPw8uoRqL._SX260_“Smart people do dumb things.”

Here’s the proof: How much money would you have right now if I gave you the ability to unwind any three financial decisions you have ever made? Years ago, after suffering a humiliatingly large dumb tax, it dawned on me that I have a seemingly unlimited ability to hit unforced errors and sabotage my business and financial success. I suspect you do, too. It turns out that the key to getting rich (and staying that way) is to avoid doing stupid things. I don’t need to do more smart things. I just need to make fewer dumb mistakes. The vast majority of our dumb tax is a direct result of emotional, overly optimistic, and poorly thought-out decisions. Every one of those three decisions you would love to unwind was an avoidable mistake.

Thinking is critical to sustainable success in business; said another way, business is an intellectual sport. The principles and structure suggested in The Road Less Stupid by Keith J. Cunningham will enable anyone, (regardless of the size of the business, the currency, or the industry) to run their business more effectively, make more money, and dramatically increase the likelihood of keeping that money. It all hinges on Thinking Time. This is a business book for business readers who want to learn the principles and strategies of making great decisions and minimizing risk. The structure of Thinking Time will enable you to minimize reacting emotionally and defaulting to the most obvious “best idea” available in the moment. The series of short chapters and subsequent Thinking Time questions are designed to maximize clarity and create better choices… either of which will result in fewer stupid mistakes. This is the real “secret”: The chance of success goes up when you think, plan, consistently execute the right things and worry about the possibility of loss. Here it is on a bumper sticker: Operators react and sweat. Owners think and plan.”

Many chapters can also help those in bank management as it relates to loans, loan reviews, annual reviews and the initial credit analysis.  In one bumper sticker (which is Mr. Cunningham’s way of pointing out an obvious point), he says “Emotions and intellect work inversely. When emotions go up, intellect goes down.  Optimism is a deadly emotion in the business world.”  This is particularly true when there is a new request on the table and it’s a large transaction.  Everyone is excited about the opportunity to the newest and greatest customer.  Look at us grow!  We do the normal analysis and possibly stress-test the individual credit, but we forget look at the 2nd, 3rd, and 4th order consequences.  In loans, this could be the complexity of the loan, global analysis, and determining if we have the proper information and expertise to one, make a great loan decision; two, are we capable of servicing the complexities after the loan is made and is the borrower truly willing to open up their financial life so that we can get a true financial picture? In the ongoing servicing aspect, are we in a hurry to get the annual review completed and forget or don’t get all the information for the global analysis and therefore skip the 2nd, 3rd or 4th order consequences that ultimately could place last year’s biggest and best customer on the classified loan list? Are we analyzing the collateral properly along with the cash flow in the annual review to make sure both aren’t deteriorating?  It is prudent to take some advice from Mr. Cunningham on his 5 core disciplines of thinking time and all 5 must be present.

One of my favorite chapters in this book is Chapter 44, “Cause and Effect”. In this chapter, he distinguished the difference between cause and effect. Again, in analysis and annual reviews, we look at the effect and not the cause. He describes the cause as the problem or issue and should be measured with critical drivers. He describes critical drivers as an early warning system that illuminates where the loan might be veering slightly off course and gives you enough information, so you can do something about it before the situation becomes a problem. This is different than a K.P.I., key point indicators.  In loans, a K.P.I. may be a debt-to-income ratio.  It is an effect of the most recent financial information which is already stale and historical.  A critical driver may be the average collected balance in the operating account as it relates to a month-over-month trend. You may ask yourself, what if the operating account isn’t at our bank?  Well, that may be a 2nd, 3rd, or 4th order consequence we didn’t think about in the beginning.

The first four chapters of The Road Less Stupid set up the discipline, which is really thinking about things and giving an order and disciplines to achieve. The next 44 chapters are short and can easily be read in 10 or 15 minutes, and each chapter ends with Thinking Time questions.  Bankers are smart people and easily relate all these topics to banking.  I highly recommend this book and if you enjoy it, Cunningham has another book, The Ultimate Blueprint for an Insanely Successful Business.” It’s about optics and measuring the correct optics and can easily be translated into your bank.

David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, bank loan review services, and bank consulting services to community banks in Oklahoma, Texas, and Kansas. 

Saving the Sinking Bank

by David McSwain

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Rural populations continue to decline, so what does that do to a local bank? How does a community bank survive when its bread and butter – the people and the businesses owned by the townspeople, are moving away or dying out? The pool of customers gets thinner each year. What’s feeding the local economy?

Technology — and especially mobile tech — is increasing at an increasing rate. It’s the “me, me, me/now, now, now” age. People want their money zipped through their phone not only to retailers but to each other. The time that customers could only choose from the local banks to do business is long gone, making the choices open for them, and the competition tighter for the banks. Cash apps and mobile-friendly banking seem to be the norm rather than an outlier these days and growing…

Customers continue to highly rely on credit to get by, maxing out credit cards not only around the holidays, but getting one too many credit cards without the ability to pay them all off. Credit scores plummet. When it comes time to get the loan, yeah, thanks, no, thanks. It becomes a bigger risk for the bank. Johnny’s burger fry shack can’t get the loan because he financed the boat, the house, and Jim and Jill’s college education.

Times are tough on banks, yes. So, what is a sinking bank to do? Can they not only survive but thrive?

Saving Tactic 1: Be innovative. 

Change is tough, and most people only feel comfortable doing what they’ve done in the past. Yet with changing dynamics in how and where people are doing business, banks must also change. Being innovative can mean reaching out to new markets, including other towns and even types of industries, and even becoming an online bank. Banks that never had to market or advertise in the past must now decide who they really are, how to position themselves to stand out, who they want to attract and then go after that business aggressively. No more just opening the doors and hoping people will walk in, or even drive though! This means employing people who are not simply paper pushers, but who are good people-people and salespeople. People who understand banking is a business that needs to attract business, not a commodity. Diversify. Own a niche for lending. Go for what the other guys aren’t. Become an expert in one area. What’s your specialty? I know of banks who have niches as an airplane lender, one that focuses on SBA loans and another that specializes in loans for vets across the country.

Unfortunately, a lot of community banks are behind on this front, but it’s not too late.

Saving Tactic 2: Exit Strategy

Can’t go it alone? Nothing wrong with that. Maybe it’s time to talk merger or being acquired, or your bank buying another! Join up with others who are doing what you’d like to be doing. There is great power in numbers, especially if it’s the right fit. Explore it. When I drive through a small town, I know if a community has a good bank because it’s thriving. That’s right. Just the opposite of what you might think. The town is not deteriorating. Streets are clean. The school looks good. In most cases, if you support your community, it will support you. Back in the ‘80s in Oklahoma, Gene Rainbolt bought many banks at a discount and made Banc First into one of the largest and most successful state banks in Oklahoma.

Whether it’s innovation, a fresh workforce, a new market or a merger or acquisition, the time is now for banks to look at not only surviving but thriving.

David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, bank loan review services, and bank consulting services to community banks in Oklahoma, Texas, and Kansas. 

When a Bank Goes Bad

by David McSwain

IMG_3994Creep. Not as is the guy in the scary movie, but how the creep factor turns a good bank bad over time. See, policies are put in place for a reason and, yet the lure of risk means a bank sometimes thinks it’s okay to go on the edge a little bit, to ignore the policies, to turn their backs on discipline and take a risky loan.

Let’s say Banker Bob knows Jane in the community and she’s a nice person, but doesn’t have much capital and has a lot of charisma and passion but not a good handle on her financials. But Banker Bob trusts Jane and gives her the loan. Banker Sue sees Banker Bob make that loan that didn’t meet the criteria of the bank, and thinks, “Hey, I know Tom was wanting a loan to expand his fitness center.” Like Jane, Tom also doesn’t have the capital or good cash flow, but goes on the edge and gives him the loan anyway.

Score for the bank and the banker, right? The bankers get bonuses and praise all around. At least for a little while.

That Domino Effect is what happens when a bank goes bad. The creep factor means it’s building up like the sands of time and eventually can bury a bank. Unfortunately, banks don’t see it coming until it’s too late. Because life happens: Jane ends up getting a divorce and can’t make her payments, or a new fitness chain moves to town and lures all of Tom’s fitness clients away and he’s in default of his loan because he doesn’t have enough revenue to keep the lights on let alone the bank.

Both are still good people, but it was a bad business decision on the part of the bank because neither client had the necessary benchmarks for a good loan.

What’s even tougher than saying now to a neighbor is that as a culture, we live out on the edge. Living on credit. New house, new mobile phones, braces. It’s the customers that create this culture that the banks feel they must bend over backward to meet. Humans find it difficult to say no and never believe “Winter” is coming.

When everything is approved on the edge, it can seem like earnings are up…at least for a little while. Things rarely go bad with liquidity problems — they go bad with lending discipline. Earnings plummet. Classifieds escalate, Charge-offs are hyper, cash flow goes down, clients don’t pay, then liquidity and capital problems begin bleeding through the entire bank.

That’s how a bank fails. Greed gets in the way, however unintentionally, and no one recognizes it. It can go fast or slow.

How to fix it? Do what we are supposed to do in the beginning within the loan policy adherence. We come in and hold accountable the disciplines. Ask more questions. Dig in. Be an advocate for sound financial management. A banker in this century must be a service provider, a mentor in some ways, not a handout or a tight-rope walker.

The banking team may be the best and brightest, but it can be tough to color within the lines and find the clients who do meet the requirements, so the bank can safely make the loan request and help the client succeed in business and in life.

A bank doesn’t have to go bad. It is possible to not only survive in this culture but to thrive with the right policies and discipline in place to see it through.

David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, bank loan review services, and bank consulting services to community banks in Oklahoma, Texas, and Kansas. 

Hallmarks of a Risky Loan

by David McSwain

IMG_3996Risk assessment can be life or death for a bank. Do it right, it’s a win-win for the bank and the customer. Getting it wrong is like hitting an iceberg you didn’t see coming. Hit enough of them and the ship sinks. The key, then, is finding the sweet spot when it comes to risk v. reward by identifying the risk in the first place and knowing what to look out for. Fewer icebergs. More smooth sailing.

Here are the hallmarks I’ve identified in my thirty years of loan risk assessment and reviews:

  1.   The customer doesn’t provide adequate information. Current financials are a must and strict adherence to the list of what’s needed is important. In fact, if the customer cannot get you what you need in a timely manner, then most likely they are a ship without a GPS.  It can be because it’s an inconvenience and it takes time out of their day to find what’s needed, but that doesn’t mean the bank should slide on obtaining the information. Dig in. Get it, or leave it. Assumptions are a bad thing and any laziness on the part of the customer or the bank can provide trouble down the road. Trouble spelled S.I.N.K.
  2. Not enough collateral coverage. Generally, you need more than you think you need. When a loan goes bad and you must sell the collateral and most of the time at discount prices, it’s rarely enough, so you’re not covered. Get more if possible.
  3. The borrower doesn’t understand their business cycles. Perhaps neither does the analyst. This is a cousin to #1, but this one plays out over time, because they may not be accounting for the seasonal or market changes. When a post-mortem occurs on a loan, and you go back to the initial underwriting, that loan shouldn’t have been made because policy disciplines were not held in place. It could be based on information for that industry, too.  Consider oil and gas loans. You must understand that the industry is volatile over time. It can be risky in the short-term or long-term because it’s a volatile industry.  Stress-testing the customer and industry is important.  Real estate can have large swings, and it does go up and down but over a long period of time it has historically normalized.

A lot of banks don’t have an accurate assessment of cash flow until the deal goes bad. Even those who know their cash flow doesn’t mean they won’t fail.  Remember, everything a bank does is leveraged, using someone else’s money. So how do we avoid the three big hallmarks of a risky loan?

Tick off these musts and you’re more likely to avoid rough waters ahead.

  • Know what you are doing. Have the right loan policy for that loan, which means having a variety of loan options based on the industry and proper speed bumps.
  • Be aware of that industry. If you don’t know it, research it and even get to know it in person.
  • People loaning the money should understand cash flows to stay abreast of how the borrower is doing. Stop in. Read up. Stay engaged.
  • Have adequate cash flow and collateral. Some bankers don’t understand that even if they get principal back, they still lost money on loan. How? Look at the principal and interest in its entirety. If you don’t collect it, you have opportunity cost. Most bankers don’t count that as a loss, but it’s an impairment that can come back to bump you like that iceberg.  Know the cost of carry for a bad loan. Add in legal expenses, lack of collecting interest, liquidation expenses. It adds up in a hurry.

David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, bank loan review services, and bank consulting services to community banks in Oklahoma, Texas, and Kansas. 

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Why I Do What I Do

Bankers.  I have been one since 1986 and it’s not all pretty. I believe in telling the truth and getting real so here we go. I have worked in most positions in a bank except for President.  Hell, I even owned a portion of a bank on two different occasions.  Although I didn’t have the title, I ran three banks for a period of two years.  I managed two banks for a period of four years and experienced things no one should experience in a bank. I had to take lending authority from family members, fire board of directors, lose friendships, and everything in between.  My expertise is instilling a disciplined credit culture that is efficient, very profitable and excruciatingly effective.  Only if you have the discipline to follow.

Here’s the thing: bankers are notorious for taking the most inexperienced person and shoving them into a position. This person unfairly gets the opportunity to check off a box from a strategic plan or from being written up from an examiner.  Bankers, really!  It’s a traditional practice from teller all the way to the top management.  We then think we have accomplished something because it didn’t materially affect the bottom line.

If you haven’t done it, you  probably know someone who has because it runs rampant.  It’s a mirror mentality.

Every time a new best practice comes out or a new regulation comes out, we hire Janie or Johnnie and put them in a position or we move Johnnie or Janie into a position they have never heard of much less have a clue of what the hell they are doing.  And neither do you!  But it makes us feel good!  We beat the system.  Nope.

That’s why I’m here. I hold up the  mirror.  We take a look at what we’re doing, why we’re doing it, and how to do it better. The truth hurts sometimes, but it leads us where we need to go.

Question:  How many of your credit analyst or loan review specialist can see a loan going bad two years out?  Answer:  Very few:  They don’t have the experience.  More precisely, they haven’t enough bad experiences to see it coming!   That’s why community banks hire McSwain Consulting.  You don’t pay us benefits, sick leave, vacation days, 401k.  We save you the x factor and generationally, our work ethic is beyond belief.

We have seen, done and walked in your shoes.  We have dealt with regulators in extreme situations, loan review companies and auditors.

Our mission:  We strive to develop the culture of discipline in loan risk management that is proven time and time again.  It is profitable, efficient and creates opportunity beyond belief.

Give us the opportunity to prove to you, but you have to follow our direction.  We will make your bank effective, efficient and more profitable.

If you are interested in taking your bank into the next generation, I’d love to get your call.

David McSwain is an Oklahoma bank consultant and president of McSwain Consulting providing loan risk management solutions, bank loan review services, and bank consulting services to community banks in Oklahoma, Texas, and Kansas.