Chapter 4: Moving the Pricing Process Forward
As you’ve probably noticed by now, we really like to use stories to help make our points when discussing our pricing philosophy. So we’ll start this chapter with another one – a hypothetical step-by-step account of a borrower trying to make his way through the traditional loan process. Along the way we’ll keep track of the time spent for each step, as well as the total process time.
The Traditional (Slow) Borrowing Process
Step 1. The borrower comes to the bank to discuss a loan request. If they are experienced borrowers they will bring most of the financial documents needed. (If not, the bank will request financials before discussing any terms, adding a week to the process right off the bat.) At this meeting, the bank will usually quote something from the rate sheet or standard starting structure. If the borrower wants anything different, the lender replies, “Let me check with my boss.”
Step 2. The lender consults with his boss, who says, “If the underwriting is good and the deal hurdles (i.e. it has a sufficient ROE when plugged into the pricing model) then yes, we’ll do that.” Invariably, a request is then made to the borrower for additional documents. (1 week for step, 1 week total.)
Step 3. The borrower gathers the additional documents and sends them in to bank. (1 week for step, 2 weeks total.)
Step 4. The bank begins the underwriting process. The credit department enters the deal into its pricing model and gets a result that is below the hurdle. The lender goes back to borrower: “We can’t do those terms. If the rate is x%, then we should be good.” (2 weeks for step, 4 weeks total.)
Step 5. The borrower counters, and we start again with the “Let me check” process. The deal goes back to the boss and the credit department, where they have to decide whether to take less or lose the deal. In this scenario they take less (which they usually do). The decision takes another two weeks. (2 weeks for step, 6 weeks total).
In summation: You have roughly 10 weeks of time spent to produce one below-target deal and one rocky relationship with a disgruntled borrower.
The New (Quick) Borrowing Process
Contrast that to the experience that the borrower might have with one of the growing number of peer-to-peer lending companies out there, like Funding Circle. In a September 2014 article in Entrepreneur magazine, Funding Circle Co-Founder Sam Hodges claimed that “businesses can now apply for a loan in as little as 10 minutes and, if approved, receive funds in their account in less than two weeks.”
Even if you assume that Hodges’ estimate might be on the opposite end of the spectrum, there’s a broad gap between 2 weeks and 10.
However, there are still multiple advantages that traditional banks enjoy over their peer-to-peer lending competitors. Bank rates are typically cheaper, and they bring an expertise to the table that peer-to-peer lenders can’t match. While filling out an online application in the comfort of your home may sound nice, there’s something to be said about getting the personal time and attention of a lender who can help walk you through the process and build an on-going relationship with you.
But there’s a reason why peer-to-peer lending is grabbing market share. Borrowers are often willing to overlook the disadvantages for the sake of a much faster loan process. On its site, Funding Circle features a case study on the furniture company Yogibo, which used a Funding Circle loan to expand its operations.
“I had great opportunities to grow our business that I just couldn’t miss out on,” Yogibo founder Eyal Levy told Funding Circle. “So I looked for a lender that was ready to think creatively and make quick decisions.”
It’s imperative then that banks take steps to shorten their lending timelines and to be more creative with the options they offer borrowers. To do that, they must move the pricing process from the back of the bank to the front.
The Siren Song of One More Report
The 1999 cult-classic movie Office Space really seemed to capture the frustration felt at businesses all across the country. Why did it resonate with so many? Perhaps because, as over the top as it tried to be, it somehow managed to land squarely in the realm of perfectly realistic. Like this famous scene:
Bill Lumbergh: Hello, Peter. What’s happening? Uh…we have sort of a problem here. Yeah. You apparently didn’t put one of the new coversheets on your TPS reports.
Peter Gibbons: Oh, yeah. I’m sorry about that. I, I forgot.
BL: Ummm … yeah. You see, we’re putting the coversheets on all TPS reports now before they go out. Did you see the memo about this?
PG: Yeah. Yeah. Yeah. I have the memo right here. I just uh … forgot. But, uh, it’s not shipping out till tomorrow, so there’s no problem.
BL: Yeah. If you could just go ahead and make sure you do that from now on, that will be great. And uh, I’ll go ahead and make sure you get another copy of that memo. Mmmkay? Bye bye, Peter.
Lenders watching that scene probably shook their heads ruefully and thought of their own version of the dreaded TPS report at their bank – something that the back of the bank keeps insisting on using, but which doesn’t do anything to help lenders do their jobs.
That report has its roots in a common bank disconnect. When loan officers are sitting with the customer, battling the competition, trying to set customer expectations and still secure good loans for the bank – every time they cross the finish line, it feels like a win.
But when the loan committee sits to review the terms and sees the compromises made in order to land the business, the finish line seems nowhere close.
The prescription for shrinking that gap is often a detailed report that can be shown to the lender so they’ll better “understand the nuances.”
These reports are generated and used to “educate” lenders – an education that can feel like getting beat over the head. In many cases, the report only increases resentment between the two sides and it doesn’t actually change the behaviors that are causing the internal conflict.
In response, many banks continue their quixotic quest for the perfect report, the one that will finally close the gap and ensure that all the lenders’ deals are up to the standards of the review committee.
But that’s not the issue. The problem isn’t about what the report says. It’s about when that information is being shared with the lenders.
Your Lenders Are Your Quarterbacks
Imagine you’re the quarterback of your favorite football team. You run a series of plays – a couple of runs mixed in with a few passes – but are eventually stopped by the defense and are forced to punt.
You come over to the sidelines and sit on the bench in silence. No coaches come over to discuss strategy. No one calls down from the coaches’ box above.
The same scenario unfolds time and again. You can’t solve the riddle of the opposing defense and you’re not getting any helpful feedback about what’s happening. At halftime the coaching staff talks among itself while you sit and stew.
The second half is more of the same. It’s not until afterward, when your team has struggled to score and you’ve absorbed another loss, that a coach approaches you.
“Here’s what happened,” he explains. “And here’s what you should have done.”
You swallow down a string of expletives and resist the urge to stuff the coach into one of the nearby lockers. Instead, you keep your anger in check and state the obvious:
“That’s good to know. It would have been really helpful to have this information DURING THE GAME!!!”
Go ahead and chuckle at the absurdity of that scenario, but if you’re a lender you’re probably looking for a nearby wall to bang your head against. Because for you, this scenario isn’t absurd – it’s the way many banks handle their reporting process.
The most successful banks are the ones that empower their lenders with knowledge they can use “in the moment” – while they’re actually pricing the deal.
To do that you need a communication system in which your lender is treated like a quarterback – and not the one in our previous absurd scenario. During a game, the quarterback is connected with an array of coaches – his position coach, the offensive coordinator, the head coach, etc. In particular, the quarterback is receiving information from the guys up in the coaches’ box, where they can see the entire field.
For a lender, that would be like getting feedback during a deal from the CEO, the Chief Lending Officer, a Credit Analyst and other key decision makers. Like the coaches up in the box, they’re the ones who can see the big picture – your goals and your entire portfolio.
Obviously, you can’t have all those people at the table for every single loan deal. But you can give the lender feedback much further upstream than the dreaded after-the-fact reports they’re now receiving. Ask your lenders what type of tools they need to win more deals and build stronger relationships while they do it. Then compare their answers to the tools you’ve put in front of them.
Hopefully you have the former. But even if you do, there’s more. It’s not enough to simply give your lenders the right pricing tools. You also have to trust that they’ll use those tools correctly.
Be Like Wooden: Try A Little Trust
John Wooden is arguably the greatest coach in basketball history. There’s certainly no debate that he’s at least on the short list. At UCLA, Wooden presided over a college basketball dynasty that will never be equaled, leading the Bruins to an astounding 10 national titles in 12 years, including seven in a row from 1967-73.
But Wooden’s impact went beyond just the college basketball record books. He was an endless font of inspirational quotes and his views on leadership and teamwork – particularly his Pyramid of Success – resonated in the business world.
We could go on and on about Wooden’s accomplishments, but for bankers perhaps the most important thing about Wooden is what he didn’t do.
Watch any televised basketball game today and you’ll notice that the cameras spend almost as much time trained on the coaches as they do on the on-court action. Every few seconds coaches are up off the bench, shouting instructions at players, badgering officials, or trying to get the attention of either.
Watch some old film of Wooden during a game and you’ll wonder if the video feed was frozen. The vast majority of the time he remained seated on the bench. While he consulted with assistants during the game and instructed players during timeouts, Wooden spent much of the time simply observing while the action unfolded.
“Don’t look over at me,” he would sometimes tell his players. “I prepared you during the week. Now do your job.”
Wooden believed very strongly that the principal purpose of the coach was to get his team ready for the game. If the coach performed his job correctly, then the players would have everything they needed to do their “job” during the game. To Wooden, the players were the ones best suited to make decisions within the flow of the game, because they were the ones on the court and in the midst of the action. If they felt trusted and empowered by their coach, they would be loose and confident and thus perform much better.
Contrast that view with coaches who attempt to control every aspect of the game as it unfolds. You know the type – they’re the ones who insist the point guard look over to the sideline before every offensive possession. They give each player a set role and demand that they stay within it. Players who fail to follow those guidelines quickly find themselves headed to the bench. These coaches are all about avoiding mistakes instead of creating opportunities.
That approach does often limit the number of errors, but it can also lead to players who no longer use their instincts on the floor. Instead, they look for approval from the bench before every key move they make – or they simply stop making decisions for fear of being wrong and getting pulled from the game.
How do your lenders perform when they’re attempting to make a deal with borrowers? Do they have to “check with management” before trying something beyond just adjusting the rate? Or do they simply say no to deals that don’t fit within their pre-set instructions?
Is that how you want your lenders to do their jobs? Or would you rather them be able to analyze the situation and make adjustments to the deal, confident that the decisions they’re making will help both the bank and their customer?
Who wouldn’t want Door No. 2 in those scenarios? But to do that, you’ve got to channel the bank’s inner Wooden. You’ve already prepared your lenders by giving them the tools to make decisions within the flow of the game … err deal. Now you need to step back and let your lenders use those tools when it matters most.
It’s not an easy thing to do. There’s a reason why so many coaches would rather stalk the sidelines and shout instructions than sit on the bench and put the team’s fate on the shoulders of their players.
But there’s also a reason why the wall outside UCLA’s locker room is covered with national championship banners.
Wait a Second…
After reading those last two sections, you may be saying something like this:
“Wait a second … Isn’t this a contradiction? First you told me that my lenders need more input during the course of the deal. But then you told me I need to back off and let them handle the deal themselves. Which is it?”
It’s both, but we get the confusion.
Here’s another way of thinking about it, while continuing to lean hard on the sports analogies.
During that hypothetical football game, you want information from your coaches, but, as the quarterback, you’re still the one who has figure out what to do with that feedback. You still have to decide whether to call the main play or change to an audible and then, after the ball is snapped, you have to figure out which receiver should get your pass.
You don’t want to be out there on the field without any information and feedback from your coaches. But you also know you can’t hike the ball and then turn to the sidelines to get approval for what to do next. The defense doesn’t have that sort of patience. Neither do potential customers, when you’re trying to negotiate a deal.
The Bank Loan Process, Take Two
Let’s go back now to our original hypothetical borrower scenario, but let’s change some things around using the lessons of this chapter.
Step 1. The borrower comes in for a loan. The lender quotes a rate and the borrower comes back with something different. The lender checks his pricing tool to see if the borrower’s loan terms would reach the bank’s targets.
Step 2. The tool lets the lender know that the borrower’s proposal won’t hurdle. “Let’s see what we can do,” the lender replies. “Tell me more about what you’re looking for in this loan.”
Step 3. The lender finds out that, while the rate is important to the borrower, the borrower isn’t terribly concerned whether the loan is for 60 months or, say, 57. The lender adjusts the deal using the shorter term and finds that it now meets the bank’s target. (Same day.)
Step 4. The deal goes through to underwriting, where it is passes with flying colors. (2 weeks, 2 weeks.)
Step 5. The loan goes to committee for final approval. This step is now shortened because the deal won’t have to be run through a model and the committee won’t have to analyze multiple structures, since the customer will have already worked through that with the lender. (3 weeks, 5 weeks)
So in this revised version of the borrower’s bank experience, the loan process takes five less weeks and many, many fewer headaches. The borrower comes away feeling better about the deal, as does the bank. And the lender comes away feeling like he can do his job, and do it well. A solid foundation is laid for what should be a lasting relationship between customer and bank.
You can see then why the pricing process benefits from moving forward, to the front of the bank. But that’s obviously much easier said than done.
Who would oversee that sort of transformation? And who would allay the fears emanating from the back of the bank, where they fret about what will happen when they no longer have absolute control over each deal?
Chapter 5: The Case for a Chief Pricing Officer
Banks have all sorts of C-suite officers from chief executive officers to chief risk officers to chief loan officers. But for some reason, there’s no chief pricing officer.
There really should be.