Lessons Learned & Re-Learned During the Pandemic

by David McSwain

As you know Covid-19 has changed everything.  It has forced every industry that can rethink how 1
work is done and where it can be performed.  Also, it has given pause to every business owner, banker, investor, employee, board of directors, and bank customer.  The lessons learned were many and they keep coming.  Not only have we been maneuvering through a worldwide pandemic, but we also experienced a very turbulent change in power in Washington, D.C.

Not since I began my banking career in the early 1990s, have the regulatory agencies moved with lightning speed, common sense, and an approach I have never witnessed before.  This time for the betterment of the whole.  Some things you may not agree with, but most, in my opinion, are completely necessary and missed in the financial crisis of 2008 and crisis of the past.  Maybe they learned a few lessons as well.  For that I am grateful.

Cash, cash flow, and liquidity are still very critical components.  No amount of cash reserve could have been saved by most main street businesses to combat the length of time this pandemic plagued us and continues to disrupt.  These three very critical components were very exposed by the amount and number of PPP loan participants.  As we have a glimmer of hope getting to the new normal, going forward, maybe banks get back to the basics of cash reserves for their borrowers or compensating balances?

Another important diagnostic that was exposed was the very quick and important indicator, current assets/current liabilities on the borrowers’ financial statements.  If you made one or more commercial loans and you collected regular financial statements and trended appropriately the benchmarks, you saw how fast the entity’s ratios flipped upside down.  Additionally, you saw how fast cash, cash flow, and liquidity evaporated.  Again, benchmarks or speed bumps as we like to call them were not utilized in some cases that we experienced in loan reviews.

The importance of collecting financial information on borrowers at regular intervals based on the business became more highlighted during the past year.  Trending the data was even more important on many different levels.  Working with customers to get them to understand the importance was even more challenging for some.  Every business owner was nervous.  The obvious was everything became disrupted for a moment for some and still exists today for others.  We saw cash flow cycles disrupted and accounts receivables became more questionable than in great times.  

Lines of credit are a very important and very useful tool if used properly.  We recommend that if a line of credit goes on the books, you mandate a borrowing base at a predetermined level.  A borrowing base is the closest document to real-time information you can collect as long as you are collecting it frequently enough.  Also, a very important factor we experienced throughout 2020 was the lines of credits were being used for purposes other than originally intended.  The discipline to stay the course on purpose is vital.  A request outside the original purpose should give pause, in my opinion, as to a problem arising or not?

Maintain discipline in underwriting and be brutally honest with yourself on annual reviews.  Also, annual reviews are a great time to review cash positions, cash flow trends, and liquidity with your customers, particularly in the ag sector.  Annual reviews are extremely important because we don’t know what the economy will do at any given point and I believe Covid-19 has allowed us to relearn this lesson.  The economy is cyclical and changes daily, but it seems to me, the lessons of the past get easily forgotten.

…to be continued…

Thoughts? Drop them in comments or email David@mcswainconsulting.net

Optimization vs. Growth

by David McSwain

When it comes to management, we are always looking for ways to increase the bottom line.  My MLK jr McSwain-2observation is that most CEOs or Managers automatically go to the obvious, GROWTH, right? 


While cooking breakfast this morning, I was listening to the podcast “Smart Passive Income”.  The podcast host, Pat Flynn, was hosting Paul Jarvis, author of Company of One (which is a very misleading title) but that’s for another day.  Listening to the podcast gave me the idea for this blog and how I could use it to relate to Community Banking and in doing so, how  I could provide added value to my current clients and readers.

So…why not concentrate exclusively on Growth?  The new buzz word for businesses as it relates to Banking is Scalability but I believe we may be missing a step.  After listening to the podcast, I asked myself, “What if, in most cases, we have it all wrong, or at least we have it in the wrong order”?  I turned to an indirect mentor and book I often refer to when thinking about a subject.  That would be The Road Less Stupid: Advice from the Chairman of the Board, by Keith Cunningham.  So I re-read a couple of related chapters on Growth.

I realized we are missing the boat by focusing solely on GROWTH!  Banks think they need to grow their loan portfolio in order to achieve the desired level of compound earnings.  Time and time again when we are in Community Banks performing Loan Reviews and other related services for our clients the subject of strategy comes up.  And inevitably, the number one strategic subject that arises is GROWTH.  After Thinking about Loan Reviews, Credit Analysis, ALLL Reviews and Analysis, I realized as an industry, we are NOT OPTIMIZING the assets we already have.  As Mr. Cunningham describes it, “we just build another machine.”

Suppose that you are the CEO of a mining company.  You operate one mine at a time until the lode plays out and then you move on to the next site.  Sometimes you might get to thinking that you need to move on to the next site more quickly and maybe increase your production.  Maybe, maybe not!  After all, you already have the mining equipment in place.  You have already done the site work and you have built the tunnels, shafts and transportation infrastructure necessary for production. So why be so anxious to move on when you haven’t fully leveraged the assets you already have in place?

In Banking, it appears we look for the next new mousetrap that will create external GROWTH, but it appears we absolutely avoid OPTIMIZING the systems and/or processes that we already have in place.  Long-term growth is not sustainable for any business, including Community Banks, without also OPTIMIZING their existing systems and processes.  Part of OPTIMIZING systems and processes is instilling disciplines inside those systems and processes before Strategic Growth should occur, but it doesn’t seem to work that way.

What we should be doing is OPTIMIZING Credit Analysis on new or renewed loans, OPTIMIZING our servicing processes and credit administration systems.  And we should be utilizing Data Mining on our current customer base to create internal GROWTH.  I would guess there is so much more opportunity inside your own loan portfolio to hit your growth strategies for the next several years, but we miss OPTIMIZING what we already have, and we go search for the next best mousetrap, GROWTH!

Community banks, if you are interested in OPTIMIZING your loan portfolio and your customer relationships, MCSWAIN CONSULTING can help.


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.


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. 


Why Loan Reviews Fail Internally

Let’s talk loan reviews. I know, drumroll, please. This may not be as exciting as reading about heritage field pic smthe presidential campaign or the Kardashians’ latest shenanigans, but hopefully this is a heckuva lot more useful.

Loan reviews are performed to determine proper identification of credit quality.  An assigned number generally is given to a particular loan and a legend with description describes each defined category of pass, watch, criticized or classified.  Typically, we see a number system 1-5 with one or two numbers for pass grade credits.

The biggest problem with not having a third party or unbiased review is the bankers have already made a decision to make the loan.  The banker develops a personal and business relationship with the customer.  In a lot of cases, the customer runs in the same social circles and in many cases become close friends of the banker or someone in the bank. The relationship in itself cause conflict in judgement of proper grading particularly when a credit is beginning to deteriorate.

Many things are identified in loan reviews other than just credit weakness.  We look for trends in deficiencies among loan officers, trends among homogenous loans, concentrations, loans made outside of the expertise inside the bank and several other critical analyses in managing the risk inside the loan portfolio.

In most cases, bank management is too close to the decision in the beginning, too close to the customer and the indirect consequence is conflict in decision begins to creep.  Having a third party unbiased opinion creates proper grading of your loan portfolio. You may be feeling an “ouch, I’ve been there” upon reading that. Believe me, you aren’t the only one.

The loan grade directly affects your Allowance for Loan and Lease Loss calculations and analysis.  Previous experiences have shown us time and time again, loan grades are not accurately reflected in the portfolio, therefore, the ALLL is incorrect.  This is a domino effect into income, capital and a whole host of other very costly mistakes.

When you hire McSwain Consulting, we give you the best opinion of the entire risk inside your portfolio.  My company will provide you with the deficiencies identified.  What we do different is we will follow up with you to determine if things are corrected or if you have chosen another approach.  We will even provide training for the deficiencies identified.  We review your ALLL calculations and analysis along with the review loan grades to determine adequacy of your ALLL.

Why take the expensive risk?  Our work will keep you compliant with regulations and best practices while identifying deficiencies so the problems can be resolved before they become very expensive experiences.



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.