Dallas Wells recently spoke on the importance of aligning pricing with your banks overall strategy. He hits on a few of the big concerns almost every banker has when they deploy something new. For PrecisionLender, that means a pricing solution, but many of his points are applicable to any new system.
The big takeaway from this talk is how do you get everyone rowing in the same direction. When the bank turns the wheel, how do you make sure that every part of the bank is turning with you?
It’s not easy to lead such a diverse group so that everyone sees the advantages to the new path, but failing is an enormous waste of time and resources.
When you put a pricing system in place, and that can be somebody else’s system, that can be a home-made Excel spreadsheet. The idea is how do we get all the people using those systems to go along with us.
It’s a broader topic than that, and it’s a conversation that we’re having with banks all the time now. There’s all these IT projects out there. There’s all these systems that we’re wanting to put in place. A lot of that is just the pace at which things are moving. A lot of it seems to be catch up too from the whole industry having to survive through the financial crisis, and there’s a lot of new expectations because of that. Frankly there was some hard times through that too.
There’s some catch up to get systems in place that will solve some of those issues. That means that pretty much every bank we talk to has a whole long list of projects. There’s some concern about not just having the resources to get them all done, but also making sure that we get a positive return on investments once those systems are in place. The basic thoughts that we’ll go through here today, those will apply to any system that you’re working on, and we’ll talk about how we can try to align the people and the systems together.
Specifically as we get into pricing solutions, we think of pricing really as a steering wheel for your bank. It should be the mechanism by which we are guiding production onto the books, but a lot of times we feel like we’re cranking away on that steering wheel. In other words, we’re making changes to our pricing model. We make small little tweaks and then nothing happens. The car itself is not attached to that steering mechanism, meaning that the lenders are just going about their business. Their pricing deals the way they’ve always priced them, or they’re, at best, coming in after the fact and putting in the terms that they’ve agreed to into the pricing system, and we’re giving them a report card. How well did you do in that pricing discussion, or how bad did you do in that pricing discussion?
We’re not doing a very good job of actually altering the behavior and getting people aligned with us. What we need to do, and the goal here today is to think through some of those issues. That is, how do we get this steering wheel hooked to the car so that as we make these small little adjustments, we tweak things, we tweak assumptions to reflect new regulatory realities, to reflect new realities in the marketplace, or changes in bank strategy. Now when we turn the wheel, all of the bank will turn with us. All of those lenders and users of the systems will be rowing in the same direction. We’ll be able to get everybody to turn, and we can do an about face, and move with some speed that we need to in this new economy.
The way that we started thinking about it, and we’re spending more time and attention on this process. It’s the real question of what does success look like? It really comes down to these big three categories.
The first step is finding those right systems. This is one that banks have shifted with a little bit and it seems to be a pendulum that swings back and forth. Banks go from wanting to go with some tight integration, and what that’s meant in the past is keeping most of the shopping done with your core systems provider and we’ve found that that doesn’t always work very well. They’re pretty good at that core system. They’re pretty good at debits and credits and keeping track of transactions. All of those other things that we’re trying to do in the bank, they’re not so good at.
We’re seeing the pendulum swing back now the other direction where banks are really seeking out some best of breed kind of systems, and let’s find ways to make those work together. All of that’s gotten easier as the technology has progressed. Especially as we’ve moved into some cloud-based kind of systems. They’re designed around moving data from one point to the next. They can do that securely and safely, an all those things that we care about as banks. We’ve improved on that. That’s allowed banks to now start making some of these investments in state of the art systems. That’s step one.
The problem is that sometimes these are substantial investments and it hasn’t been that there’s an unwillingness to spend. Banks have been spending a ton of money on technology. It’s not that we’re cheapskates, it’s that we’re worried about those next few pieces. How do we actually make sure that we get some use out of this? As we dig into this when we’re talking to banks about their concern about these multiple projects that are going on, a lot of the concern is that they’ve been burned in the recent past. They’ve had these projects that have promised to be easy, and they’re not so easy. Then the end result is less than desired. They get either minimal usage at all, they just don’t get the end users, the rest of the staff there at the bank to use the systems, or at best they’re using them, but they’re not using them how we would expect them to. We’ve bought the Ferrari and they’re using just the Oldsmobile kind of features. We’ve put these powerful tools in their hand and they’re not getting used.
Those three things is how we’ll really get there. The system’s number one, number two, the focal point has to be first to processes, what are the expectations, and how do we put the right rails in place so that the people, that third step and really the most difficult one will get in line when you use that system consistently, and the way that we need them to to get the most out of that system. I’ve been around working in and for banks for a long enough time that I understand that’s a really difficult one, getting a bunch of bankers to move in the same direction, especially around new technology, is definitely like herding cats so that’s the tricky one. That’s the one we’ll spend some time on today.
Really this is where we need to get beyond the configuration. That’s where so much of the focus is as we buy new systems is, how do we figure out how to use it, and which dials and knobs do we turn to get the actual system to do what we expect it to do. There’s so much more to it than that. That’s really where we’ve been rebuilding our own onboarding process over the last couple of months. We’ve always had a focus on those second and third pieces, the process and the people, but we’re now putting even more focus on them. We’re dedicating more time to those with the banks that we’re working with.
Number one is planning. That’s not just going in and immediately starting to set up based on the directions out of the box, but it’s thinking about what do we really want and need out of this system, and how’s it best going to work for us, and what’s the end goal, what do we really want to do?
Once that planning is done and we have the right goal set out in front of us, then we’ll actually get in and configure the system, get the basic setup done, we’ll get the infrastructure in place. That’s the system’s piece.
Then we move to what we call engaging the users and that’s really where we put down the processes. How do we expect these people to use the system? What kind of resources do they have? How are we going to engage them? How are we going to make sure that they know how to use it, and that it’s easy for them? How do we break down those barriers that are inevitably going to be there when we’re dealing with a very broad, very diverse skill-set kind of user base?
Finally, we need to measure and improve. Especially as systems have gotten more sophisticated, more interconnected with other systems, we need to make sure that we’re continuing measuring those goals that we set out in that first box. How are we doing on those?
We’ll go a little more into detail on that basic overview there, and starting with the planning phase around those systems. This one’s very specific to pricing, and this is a diagram that we’ve been showing in a whole lot of our presentations. We talk about it when we’re onboarding with banks, we talk about it with prospects. These are basically the three things that you can get out of a loan pricing system. You’ll get some measure of loan growth, a measure of loan profitability, and some amount of risk mitigation based on how you price.
Those three things, you can get some mixture of all of those, but if you move too far in any one of those directions, there’s going to be a trade off of the other two. What we find as we talk to banks is, you’re all making conscious decisions about where you fall on the spectrum. The idea is are we purposeful about that decision, and does it align with the bank’s overall strategy? Have we intentionally made those decisions so that we’re landing where we expect to land?
For example, we talk to banks that are producing lots of loan growth, and they’re hitting the growth numbers, but they have some concerns about those bottom two. If they’re really growing fast in a stodgy business like banking, is there some profitability being left on the table? Most definitely. Is there some undue risk maybe landing on the balance sheet? Probably so. We maybe are making some tradeoffs with those bottom two to reach that growth goal. Remember, those banks that are struggling with growth, the product that we’re selling is money so it’s not like demand is an issues. Fact is if the price is right, it’s an unlimited demand. That growth number is not that had to hit, but there is that trade off.
Same thing with profitability. You focus on profits exclusively, there’s going to be some trade off of the other two. The growth would make sense. The one that people sometimes forget about is that risk mitigation one. Where we often see this is with those banks that really haven’t adjusted very well to the new reality of net interest margins so those banks were structured around when the four plus, sometimes close to five percent net interest margins were not just obtainable, but maybe more the norm.
Now that that’s no longer a reality, now that that is an unusual thing to find, that interest margins that high, they’ve now been able to adjust their overhead structure well enough to make it that they’re a viable, profitable business. They get very stubborn about pricing. We always want a minimum spread of at least X. We got to have that four plus percent in that interest margin. You can probably get that, but you’re going to grow very much. The deals that you do get are going to be those often where you’re the lender of last resort. They’re landing with you because no one else has agreed to do the deal at a better price. Again, you’re making a trade off.
Similarly for risk mitigation. Some of these are the banks that were burned the worst during the financial crisis, or they’re just in markets where they feel that growth is hard so they really focus on, we just really don’t want to lose any pennies. These are your 40 and 50% loan deposit type of banks typically. There’s not a whole lot of spread left there. Deposit rates can only go so low, and when you’re putting it all out in the bottom portfolio, it’s really hard to generate enough net interest income there to really keep the lights on.
You’re forsaking growth, and you’re definitely forsaking profitability. You have to find the right balance of these, and again the point here to take away is to be intentional about it. It will change over time as the bank strategy changes. Once we know where we’re going to be on this spectrum, then we can align the pricing pretty precisely to end up exactly where we want to be.
Getting into that process and people issue, talking about engaging the users. Again, this is the hard part. The buying the systems is where all the focus has been. That’s where we put the time and attention. I can promise you as a vendor to banks, we feel that new vendor due diligence expectation from the regulators so we know that there’s a lot of time and effort going into that, but we’re not done once we decide to buy it. There’s a whole another set of steps that need to take place. It starts with the process. Some specifics on the process, and these are again specific to pricing, but with the same concepts if you think big picture will apply.
Number one, things like a requirement that all loans over X dollars get priced in your pricing solution. This is really important for consistency. Number one, to make sure that the reporting outputs that you’re going to use from that system are actually useful. They’re actually going to be accurate, but it’s also really important to get over that initial threshold, that initial hump of getting the users engaged and getting them to use the system.
The trade off here, what we see fairly often is, if you don’t require that all loans get priced and saved in the system, then the lenders will use it as an occasional tool. They will bring the output through pricing committee. They’ll bring the pricing sheet with them through committee when the deal looks really good. When the deal doesn’t look so good, it won’t show up. Then when the other lenders see that, a loan goes through committee, there’s no pricing sheet, and nobody calls them on it, then they know they can get away with the same thing. So usage will pretty soon fall away to next to nothing and your shiny new model that you’ve put together and probably have some expense involved with, either for purchasing it, or the time and resources it’s going to take you to build something, all that’s for not. You’re not getting any use out of it.
The second process to put in place is the who and the when. Specifically, who’s pricing the deal and when are they pricing it. In our minds, the measuring of how well you priced is important, but it’s not as important as actually getting a change in action, a change in behavior. That means for that to be able to take place, we have to have the lender, or whoever is having that discussion about pricing, they need to be using the model, and they need to be using it while they’re having that discussion with the borrower about what the price is. Not after the fact. Not after we’ve already come to some basic agreement because we think we know about where it’s going to land. We have to do it in real time. Again, because if we’re wrong, if we’re not where we need to be, we need to have it at our fingertips then so that we can actually change the behavior. If we do it after the fact, we may learn from that. We may see that it we didn’t land exactly where we wanted and we’ll try to do a little better next time, but that’s not nearly as effective as seeing it in real time.
We see a lot of banks that will again, spend the time, and money, and effort in either buying, or building, or both a pricing solution and then the lender has the discussion with the borrower like they always have, and then they say, “Oh yeah, I got to put that new this new pricing model that they’ve imposed on us.” Then either a loan assistant or someone in the credit group has to go through underwriting to put the details of the deal in there. Then we get a report card after the fact. We see that really far too often. It’s got to happen earlier in the process, and ideally it’s going to be with the person who’s actually having that pricing discussion.
The third point here, is we have to have procedures in place for pricing exceptions. If we’ve got our targets, or goals, or hurdle rates, whatever your terminology is going to be for those, if we have those set correctly we should be coming out with a fair amount of pricing exceptions. There should be a decent flow of those. If we’re not seeing any pricing exceptions that’s going to tell us one of two things, either the process for getting one of those approved is just way too cumbersome, or our targets are set too easy, which means we’re leaving some money on the table.
We want to be able to see quite a few of those, and we want to have some procedures in place for what do the lenders actually do when they come across one of those? Is the deal we think that we want to do, there’s sound reasons for wanting to do the deal, slightly below the target of the hurdle that’s set out there?
What’s your process for that? I would suggest, find a way to make it easy. Think about it from the borrower’s perspective. The last thing that we want to have to tell them is check back with me in a week or two weeks after loan committee when I see if I can get this deal approved. There’s a whole lot of faster moving competitors coming our way, and that’s not going to be a good enough answer anymore. If there are exceptions, make it so we can get quick, fairly easy for the lenders, should make it so they can get approval and get back to their borrowers.
The next thing here is where to find important, what I call supplemental information. For example, in our Precision Lender system, this might be details on some of those fee based kind of things that we want to consider as we’re pricing a loan. What I mean by that is somebody who’s got, as a part of their relationship with the bank, maybe they’re going to bring us a large investment account, or we have a subsidiary that sells insurance and they’ve got a big insurance need. We want to consider those when we’re pricing the deal, but maybe we don’t know exactly how those are going to translate to bottom line for the bank. Where do we go to find that information and bring it into the process? Again, hopefully you’ve got a system in place where that’s easy to bring in and do some analysis. If any of that stuff is not readily at hand, where do they go to find that?
Then the last one, and this is the one that’s again one that’s important. How reporting will be handled. Again, as a banker I understand the desire to have a whole bunch of reports in front of you. What we try to steer away from, and our philosophy on it is a little different than that, it’s the less is more philosophy, and it’s again that focus of instead of some what we call vanity metrics, some pretty charts and graphs that will sit on the desk of a couple of people, and we see them at the end of the month after everything is done. We want to try to make a focus on getting the right information for the right people at the right time. Get it to them when they can actually make some meaningful decisions based on that data and we can actually move the needle a little bit. It’s not easy to do, but that’s why for example in our system, we don’t just have a big report writing engine where you can just fill out these report packages that get generated at the end of each month.
We want you to think through that. We’ll help you build those, but the reason is we want to see where that information is being used. We want to ask lots of questions about it so we can get it to the right place, and really the end goal there is if it’s something that needs to be included within the application, that’s again seen in real time as we’re pricing the deal, we want to find a way to build that in rather than just give you a report for later.
The people specifics. And again, this is the herding cats piece, this is the difficult one, the one that we need to spend more and more time and attention on going forward as we include more systems and more complicated systems into our process. Number one is pretty straight forward, it’s accountability to those process that we put in place, and that is hold all people accountable. That means if we’ve got a pricing model that we’re putting in place, a pricing solution, and the senior or the big producing lender doesn’t really like to use it, a lot of time our tendency is to say, “You know what? Let’s just let them do what they do. Let’s not interfere too much or try to change what they’re doing.”
There are two bad outcomes there. Number one, the other lenders are very likely to follow suite when they see that the top producer’s not getting anything out of it, why should they bother? Number two, if we want anybody using it, it should be those top producers. Those are the ones who are generating an out sized share of the results so we need to have the pricing model directing those results if we actually want it to change anything.
Number two is pretty straight forward, share and reward the wins. That is obviously the big trophy deals that we win. We definitely want to celebrate those. We want to point out how we got them, the process we went through, what everybody learned from those, but we also want to talk about the smaller ones and the ones that are maybe unique in different ways to use the systems we put in place. If somebody’s got a creative solution, again share it, publicly pat them on the back for that so that they get credit for it. Other people want to do the same and we learn the specific trick that they used to get some success out of it.
That’s a little bit related to the next one which is, use good old fashioned peer pressure. This is a pretty cheap way to motivate staff. It’s certainly cheaper than an incentive comp plan, which is not only dollars out the door, but also some compliance risk at this point. Peer pressure is pretty powerful. We’ve seen banks go so far as to stack rank their lenders. You don’t have to go into a lot of detail, but just put that ranking in a list up on a slide during a loan committee meeting. Nobody likes to be on the bottom. Everybody likes to be on the top. That will change behavior as long as you keep the metrics simple, that they know how to get from the bottom to the top. That does a lot more to change behavior than just about any bonus plan we’ve seen anybody put together.
In our system the way we go about that is every lender sees their own performance versus their ROE targets. Green is good, red is bad. They can see how much of that they’re doing, versus what all the other lenders are doing, versus what the bank overall is doing.
The last one, again specific to pricing, incentivize risk adjusted profits and not just portfolio size. We go through all this effort to measure how much risk adjusted profit is in each deal, and then we get to the end of the year, and the only thing that we really talk about and hold them accountable for is how much they grew their portfolio. Those two things need to align better. If we really are about dollars of risk adjusted net income, start incentivizing on that because who cares how many dollars we had to put in place to get them as long as we get the dollars from that income. In fact, if we can get it on fewer dollars outstanding, that’s a good thing. That means better ratios and more capacity to do other things.
Measuring and improving
This is a process that we put in place last year where we have regular touch points with every client. It really has helped with how well the banks are using our system so I think this is one that will again, apply across the board. It’s these basic questions, and I won’t belabor these too much because I think they’re pretty straight forward, but on each one of these check-ups that we have with clients. We talk about, are we happy with the recent volume and profitability? How are we progressing towards budget numbers? There’s a loan goal at the beginning of the year for every bank out there. How are we doing towards that goal? Has the market shifted? Has our strategy shifted? Has anything changed? What adjustments do we need to make to pricing based on that.
I think we’ve all figured out that we start these annual budgets and by the end of the first quarter, they’re usually pretty stale. We know that the business moves fast, we know that objectives change fast, and yet we look at pricing targets and assumptions that are put in pricing solution and a lot of times they’re a year and a half or two years old. You need to be updating those tools to reflect your new way of thinking about the world, and how the world has changed around you. If you’re not happy with the results, change something in there and move it. If you’ve done the other pieces, if you’ve got the right processes in place, if you’ve got people consistently in the system using it like they’re supposed to, it will start to make a difference. If you’re not there on loan growth, lower the targets. Volume will pick up as long as people are using it consistently.
There are some common road blocks. We run across these on a fairly regular basis as you will with any system that you’re going to put in place. Again, we’re talking about complex systems and complex organizations. There’s going to be difficulties. Some common ones, number one is inconsistent usage. That thing I touched on earlier, only the good deals get priced.
The second one is ROE hurdles instead of targets. Meaning we set these minimum targets out there, minimum hurdle rates out there, and when we see deals come in and get priced, we’re pretty comfortable above them. If that’s happening, that means we’re probably leaving some money on the table. Targets should be a stretch. They should be pushing most of the deals that we’ve put in there. If we’ve done a good job of setting those, we should really be right at the edge of meeting those, and we should have to be making small little tweaks to our deals to make them better before they go on the book. That’s a good target, where every deal is almost there and we’re scraping up those few basis points that are out there to get to the right spot.
Number three, I’ve covered this a little bit, mentioning the scale assumptions. A couple specifics that we see here out in the market place where this is really starting to show up. One is in revolving lines of credit. Lines of credit especially with very low utilization, and the difficulty is that these are often for our best customers. We put a revolving line of credit in place and it doesn’t get used very often. It’s just there kind of in case so there’s not much interest income actually generated off that thing. Those have always been very low profits, but that’s changed even for the worse over the last couple of years because now we have to hold capitol based on the total commitment and not just on the balance.
Those are using up some precious capitol that makes them even harder to get done. Which means those are being mis-priced all the time. When we put the right assumptions in there, some banks are kind of aghast at the actual price that comes back on those, what we would actually have to charge. What it’s coming back to is that to make those deals work, a lot of times we’re going to have to look at putting fees on the unused portions of those lines. That means that a lot of those lines are going to go away. Which in reality is probably what needs to happen.
Those alone with high volatility commercial real-estate, those HVCRE loans, those are now 150% risk weighting kind of loan, and not many banks are pricing them that way. We’re starting to see a little more volume of those. Those were essentially dead for a long time, but we’re seeing more and more of them now, and we’re seeing them be very mis-priced. We’re seeing a very wide range of prices. Some are applying that 150% risk weighting, some clearly are not so stick to your guns on those and price them how they should be.
Lastly, no competitive awareness. You’ll find some way of bringing in where the current market is so that you’re not just always pricing in the vacuum. Figure out where the competition is on those deals. There’s not a good source for commercial loan information because there’s just too many variables. The deals are too unique. What I would say is ask your borrowers, and they’ll tell you if you ask in the right way. Which is, “Tell me more about that offer so we can try to do better.”