Chapter 6: What Makes a Great Lender?
The banking industry is facing a crisis in the coming years.
We promise this isn’t like the 10,001 articles you’ve already read about how banks are being “Uber-ized” by tech startups. We’re talking about an entirely different problem.
This problem is largely self-inflicted, given the cancellation of most in-house training programs, but it also should be solvable if we tackle it the right way.
The big crisis? Banks are short on new talent. They are especially lacking lending talent, and the shortfall is about to get much larger as the boomer generation retires with few qualified replacements in sight. Consider this sobering finding from Bank Director’s 2016 Compensation Survey:
“Forty percent of survey respondents say that recruiting commercial lenders is a top challenge for 2016. When asked to describe their bank’s efforts to attract and retain commercial lenders, 43 percent say there aren’t enough talented commercial lenders. The same number say they’re willing to pay highly to fill these valuable roles within their organization.”
Why Your Best Lenders Matter More Than You Know
Why is this so important?
Every bank we’ve ever worked with has a huge variance in the level of lender production. The distribution typically looks like a power law curve, where the majority of production comes from a few big producers (which we call “Alpha Lenders”), while most of the headcount and cost comes from the average and laggard lenders.
This is true of sales production in most industries, but it is especially important in banks. All of those deals live on the balance sheet, and their makeup dictates the bank’s profitability and risk profile for years to come. Given that dynamic, the top lenders in a bank have a massive impact on the institution’s performance.
To get a sense of this, we must first take a detour and tell the story behind the “Zipf Curve. “
In the mid-1930s, George Kinsley Zipf, a linguist at Harvard University, made the first of a series of fascinating discoveries. After tallying the frequency of word use in many different languages, Zipf noticed a nearly universal distribution. In almost all languages, the frequency of a word’s use is inverse to its rank. The second most common word is used ½ as much as the most common, and the 10th most common word is used 1/10 as the most common. When plotted on a curve, it looks like this:
As Zipf dug deeper, he found that this power law curve applied to much more than language. It also applied to things like city populations, as the most populous city would be twice as big as the second largest city, and 100 times as big as the 100th largest city.
Interestingly, the distribution remained over time, so as the largest cities grew, the entire curve shifted. What started as a language phenomenon is now known as a Zipfian distribution, and it can be applied to far ranging things such as frequency of proteins in a genome sequence or even the number of Twitter followers for NBA teams.
How Zipf Applies to Your Bank
So what does this have to do with your lenders?
In banking we often call this phenomenon the “80/20 rule,” which is shorthand for the Pareto principle. (For you math nerds, a Zipfian distribution is just the discrete version of the continuous Pareto distribution, so the two concepts are mathematical cousins of sorts.)
We decided to dig into our client data at PrecisionLender to measure individual lender production. The more we played with this data, the more a familiar pattern started to emerge. First, we ranked all lenders that use our tool by portfolio size, and the result was a nearly perfect Zipfian distribution.
Much like individual books, though, individual banks also showed the same distribution. To the left is a detailed look at one bank. Its top lender has a portfolio balance over $200 million. Meanwhile, the average balance for all the bank’s lenders with a portfolio (49 in total) is $26 million.
That Zipfian data story repeated itself over and over among the banks we studied. The lenders’ portfolio sizes are represented by the colors listed on the right. All of these banks have a few big producers at the top (the aquas, greens, yellow and oranges in each bar) and most of their lenders producing relatively small portfolios (all those shades of purple).
(Bonus: The banks are listed left to right by their number of lenders. This creates – you guessed it – a basic Zipfian distribution.)
Getting More From Your Best Lenders
While this was an interesting find, we initially thought of it as a classic “vanity metric” – something interesting, without much value. But, as we discussed it with a few lenders from the top of those charts, that sentiment changed. In fact, it started to sound a lot like the venture capital business.
Fred Wilson, a well-known partner at VC firm Union Square Ventures, published a great post on his AVC blog called “Losing Money”. Here was the part that resonated:
Our first USV fund, our 2004 vintage, has turned out to be the single best VC fund that I have ever been involved in. We made 21 investments. We made money on twelve of those investments. We lost money on nine of them. And we lost our entire investment on most of those nine failed investments. The reason that fund performed so well has pretty much nothing to do with the losses. It was all about five investments in which we made 115x, 82x, 68x, 30x, and 21x.
If you chart out the returns, there were a couple of massive homeruns, a few middling successes, and then a bunch of zeroes. Fred’s point was that while the zeroes were valuable learning experiences, ALL OF THE PERFORMANCE came from the top of the curve, and his fund succeeded because they used time, money, and resources accordingly.
Loan portfolios in banks are built on similar distributions. (FYI, customer profitability also happens to follow a Zipfian distribution in most of the banks we checked.) Yet banks focus time, money, and resources at the exact other end of the curve from Fred.
In this case we are not talking about loan losses. Those absolutely need time and attention. We’re talking about all of the rules, systems, and management time put into “corralling” the bank’s least productive lenders.
You can think of the curve like this. If a bank’s top lender generates $1.00 of returns, then the fourth-best lender would generate $0.25, and the 100th best lender would generate $0.01. In other words, you have dollar lenders, quarter lenders, and so on, all the way down to your penny lenders.
The issue is that banks put rules in place to keep their penny lenders from making penny mistakes. And since there are a LOT more penny lenders, that takes a ton of effort and resources from management. In addition, those rules do very little to help your dollar lenders. In fact, the rules put in place to keep penny lenders from making mistakes actually make it harder for your dollar lenders to be creative and responsive to their borrowers.
In our world of pricing, we see banks spend inordinate amounts of energy trying to avoid pricing exceptions for their penny lenders. “Don’t do any loans over seven years. Don’t do non-recourse loans under any circumstances. Don’t offer ANY pricing below the hurdle rates.”
This creates mountains of red tape that bog down dollar lenders trying to serve the bank’s best clients. Philosophically, the bank would be willing to bend the rules and be responsive to its most important borrowers, but in reality, the structures set in place for the penny lenders make it very difficult to have that flexibility.
Think of it this way. Would it be easier to take a typical nickel lender, and double their production, or take a dollar lender, and make them a $1.05 producer? Also, if you want to move the needle on portfolio performance or asset mix, where are you more likely to make a dent?
The focus should be at the top of the curve.
The Rising Tide Lifts All Boats
And the really cool part? Remember from the growth of cities example that the distributions tend to remain intact. If you improve the performance at the top of the curve, the best lenders produce a ton of business with your best customers. That generates goodwill and brand awareness that benefits the rest of your lenders. So as your top lenders get better, they don’t actually put distance between themselves and everyone else. Instead, they lift the entire performance curve.
We’ve measured portfolio size, but what is the real impact of all of that production? To get to that number, we have to first identify the top producers, or “Alpha Lenders.” There are lots of ways we could define an Alpha Lender, but for consistency in this discussion we will keep it simple and use portfolio size as the determining factor. The average portfolio size is obviously different depending on the bank, as differing strategies create different loan mixes and organizational structures. So we used a measure of a lender’s portfolio size relative to the other portfolios within their own bank.
In most of our client banks, the top 20% of commercial lenders produce the majority of the total commercial portfolio. But the really impressive part is that they not only produce more volume, they also produce more profitable deals as measured by risk adjusted ROE.
Take a look at this bank, a PrecisionLender client, which has close to 200 commercial lenders. We divided their lenders into deciles by portfolio size, and then compared the top few groups:
The Top 20 lenders have a median portfolio size of $139 million, and generate median ROEs of 13.2%. Lenders 41 through 60 (solidly in the middle of the curve) have a median portfolio size of $26 million and median ROEs of 8.11%. That top group is allocating a giant chunk of the bank’s capital, and is doing it more profitably than all of the other lenders. Wouldn’t it be great to have more of those? How do we find or grow that kind of talent?
Then there’s the question that keeps CEOs up at night: What happens if/when they leave?
Answering those questions should be a top priority for bank management teams. The ones that get it right will be the big winners in the coming years. Those that don’t? Our guess is their banks get added to the growing M&A stats, as they will have little choice but to sell before they lose too much ground.
Traits All Great Lenders Share
Because lenders allocate so much of the capital, their success (or lack thereof) will dictate the bank’s profits and risk profile. Relying so heavily on just a few people tends to make CEOs nervous, though, and leads to a big underlying question. Are great lenders born, or are they made?
If great lenders are born, and just happen to have innate abilities that others simply can’t replicate, then the solution is simple: Start recruiting. This is expensive, and the results don’t always live up to the expectations, but if great lenders are just born that way, then the only answer is to find proven producers and hire them away from the competition.
But what if great lenders are made? What if we can train and develop the next generation of stars from within our own ranks?
To figure out if this is possible, let’s start by figuring out what makes some lenders great. What traits do they share that are so different from everyone else? We spend a lot of time talking to banks about this issue as we try to build tools for the best lenders, and the same three traits come up over and over again.
- Empathy (Embrace Your Inner Child)
First and foremost, lenders need to have empathy, and we mean empathy in the true sense of the word, not just the “suck up to the customer” approach that some banks seem to teach. Empathy means that the lender starts at the customer and works backwards into a viable deal.It can also mean acting like a five-year-old.
Child: Can I have ice cream for dinner?
Parent: Because ice cream isn’t good for you.
Parent: Because it has no nutritional value.
Parent: Umm … I guess because its makers wanted to make sure it was tasty.
Parent: So they could sell more of it.
If you’re a parent, you know this scene all too well. And if you’re an honest parent, you know that at times all those incessant questions can be downright annoying.
But you also know that asking those questions is a critical part of the child’s developmental process. Children have no built-in knowledge base, so asking questions – and getting answers – is the way in which they begin to make sense of the world around them.
It’s similar to great lending – minus the “annoying” part.
Great lenders always ask the extra question to put themselves in their borrower’s shoes. They know that the more knowledge they can gather about the customer’s situation, the more ways they can find to structure a deal that will benefit both the borrower and the bank.
What kind of project are they financing? How will it affect the rest of their business? Which deal terms are likely to be most painful to them, and which are deal killers if we don’t get them right? Empathetic lenders never start from a standard structure on a rate sheet. Making it fit into the bank’s policies and profitability targets comes later, after they have established what works best for the customer.
It’s also not enough to just fire away with question after question. Great lenders listen – really listen – to the answers their customers give.
That may sound simple, but if you’ve ever watched a locker room interview scrum after a big game, you’ll see how often people who are paid to ask questions – sportswriters – fail to do this.
Reporter: “Johnny, tell us about your game-winning hit.”
Player: “Well, I was just looking for a pitch to drive. But I really think the key was the week I spent in a sweat lodge before the game. That really cleared my mind.”
Reporter: “Uh huh. So what are your thoughts about tomorrow’s matchup?”
We exaggerate here to make a point. But often writers are so intent on getting through their list of questions (and getting back to the press box to file a story before deadline) that they fail to listen to answers that, if they followed up on them, would give them a much better story.
So how would this play out in a lender/borrower interaction? Consider this hypothetical situation we often use when demonstrating the PrecisionLender software.
Let’s say you’re trying to win a deal with a borrower for a $1MM commercial real estate loan. But the borrower says he’s planning to go with Bank Down The Street, which is offering a rate that’s 50 basis points lower.
Some lenders throw up their hands right then and there. The deal doesn’t fit their rate sheet so then, oh well. They don’t look for alternate ways to get the deal done.
Empathetic lenders start asking questions. “What can you tell me about this deal?”
Perhaps then you find out how Bank Down The Street is offering such a low rate. Maybe it’s because part of the loan is guaranteed. That could be the end of the story. But great lenders channel their inner annoying child and ask about the guarantee: Who’s providing it? What are the details?
In this hypothetical, the guarantor is the borrower’s father-in-law. Again, this could be the end of the line. But the empathetic lender – unlike the mediocre sportswriter – is listening to the answer, and he detects that the borrower is less than thrilled at the prospect of “owing one” to his father-in-law. So the lender asks more questions and finds out that the borrower would be more than willing to cut a few months off the maturity of the loan if it means he can get the same low rate and not have to rely on his father-in-law’s guarantee.
By asking questions and listening to the answers, the empathetic lender has gathered enough information to turn the tables and win another deal for his bank.
In the end, the only people truly annoyed are the lenders working at Bank Down The Street.
There is another side to empathy, as well. The best lenders know that getting a deal done quickly and efficiently relies on a lot of other people. Along the way they might need help from loan assistants, credit analysts, appraisers, attorneys, board members, title companies, and branch staff, just to name a few. Lenders might be able to steamroll those folks to get what they need once or twice, but to be able to consistently get complex transactions done, they will need to show noticeable empathy and respect for everyone involved.
2. Communication Skills
The second trait is related to the first. Part of empathizing with a borrower is understanding that, while you may be eyeball deep in multi-million dollar loan transactions every day, this is a rare event for customers.Lenders need to be great communicators who can clearly spell out what the process will look like from the beginning, including the big milestones and potential risks. Then, the borrower needs regular updates on progress, even if you are still just waiting for appraisals, title work, or approvals.Put yourself in your borrower’s shoes. They are waiting for you to get some mysterious behind-the-scenes paperwork done so they can get the capital they need. Delays (or denials) mean dead projects and lost money, so going weeks without hearing anything will inevitably lead to frustration.
Dallas’ grandfather was a construction foreman for large government and commercial projects. He was essentially a project manager, ensuring that all of the various crews and sub-contractors got their piece of the job done on time, in the right order, and up to standard. He described it slightly differently. “I basically herd cats through a hailstorm.”
Each project would have unique parameters, and would require coordination between the customer (usually a developer), the foreman’s bosses (the general contractor), and all of the various work crews for the general and sub-contractors. The day-to-day work was essentially walking around the job site, inspecting progress, and then communicating that progress to the affected parties. It was essential that the framing crew knew exactly when the foundation crew would be done so they could have the right materials on hand and be ready to start as soon as they finished. The electricians needed to know where the plumbing would go, and when the HVAC crew would be there. And the bosses always needed to know what was late, how far over budget they were, and who was to blame.
That job function probably sounds familiar to a commercial lender.
In a typical commercial loan transaction, there is a similarly large group of involved parties. There is a borrower, who will typically have partners, staff, attorneys, and possibly consultants working on the deal. If you are financing a purchase, you will have contingents from the sellers and brokers, as well. On the bank’s side you will have senior lenders, loan assistants, credit analysts, the finance team (for pricing), and approval committees.
And of course you have the litany of third-party service providers for appraisals, environmental studies, document prep and review, collateral inspections, and title work. A good commercial lender jumps into the fray and helps coordinate all of these parties, each of whom has their own perspective and agenda in a multi-million dollar transaction.
A mistake can be disastrous for anyone involved. Sounds a bit like herding cats through a hailstorm, doesn’t it?
The best lenders do a masterful job of communicating with everyone involved, just like it’s a construction job site. The credit team knows when the appraiser will be finished, and the customer knows what happens if the number is less than expected. The attorneys get notified when the title work is complete and the documents can be prepared. And of course, the customer and the bosses need to know what is late, how far away from budget we are, and who is to blame.
Bank management teams need to facilitate this process instead of just hoping the lenders figure it out. Since much of the job is really “deal choreography,” lenders should get formal training on project management and communication. Just as important, the bank should invest in some basic tools to help lenders keep all of the balls in the air.
Even if you don’t have a full blown CRM or project management system, there are lots of easy to use and inexpensive SaaS products that can be used for these purposes. Regardless of the solution you choose, just make sure you aren’t sending your lenders to a gun fight with a knife, because the big guys are starting to make large investments that will seriously outclass the legal pads and post-it notes you’re using now.
3. Quantitative > Qualitative (Avoiding “Tilt”)
When Dallas was learning the banking business, one of his early bosses taught him something really important. He said, “If you stay in this business long enough, you will eventually get burned by every type of borrower. Learn your lessons, but don’t let it get emotional.”Or put another way, when you’re a lender, you need to avoid “tilt.”If you’ve ever played poker, you know all about “tilt.”
The phrase comes from the warning sign on pinball machines that lit up whenever a player tried to “tilt” the machine to get the ball to move a certain way. In other words, it’s a pithy way of saying “off balance.”
When a player goes on “tilt” it’s because he’s overreacting to the results of previous hands, and is now letting that emotion dictate his moves. His decision making has lost all balance.
It’s a condition that’s not unique to the poker table. It also affects lenders.
What are the different types of tilt? An article at pokerology.com describes six forms, several of which may look familiar to lenders:
Berserker Tilt: The most commonly known type. This is the guy who’s had a stretch of bad luck, or has perhaps lost a hand to someone who made all the wrong moves but somehow won the pot anyway. Now the Berserker is frustrated and playing far too aggressively. He’s mad and gosh darn it, he’s going to get all his money back NOW.
Berserker Tilt (Lending version): Lose a couple of deals to the bank down the street and you can find yourself in “Berserker” mode – hell bent on winning the next one, even if the logical part of your brain is desperately trying to tell you that the numbers don’t add up.
Lily-Liver Tilt: This poor guy lost a really brutal hand – maybe his full house was beaten by a better full house, or his king-high flush was bested by an ace-high flush. The “Lily-liver” now sees losses around every corner. He’s playing scared, folding every hand unless it’s absolutely certain he has a winner. (And it almost never is.)
Lily-Liver Tile (Lending Version): You got burned by a deal that was structured well but went south later, through no fault of your own. Now you’re in “Lily-Liver” mode, avoiding making those deals, even though – again – there’s sound reasoning to do just the opposite.
Winner’s Tilt: Proof that tilt isn’t always brought on by losses. This player’s won a few hands and suddenly he thinks he’s invincible. Most likely he’s confused luck with skill and thinks he had something to do with the dealer giving him just the card he needed. So in future hands, he’ll ignore all the warning signs and just keeps betting because past results tell him HE IS THE MAN!!!
Winner’s Tilt (Lending version): You’ve brought in some deals with shaky fundamentals and they actually worked out in the end. Now you’re on “Winner’s Tilt” and you’ve mistakenly decided that this a viable formula going forward.
Frustration Tilt: This poker emotional state is brought on by, well, nothing. The player hasn’t had any cards to play all night so finally he just decides, “To heck with it, let’s make something happen!” That approach does indeed “make something happen” … it’s just usually not something good.
Frustration Tilt (Lending version): It’s a slow time in your market, so you decide to force the action. You offer loans at significantly lower rates, or you close deals with higher risk ratings, because hey, shaky deals are better than no deals, right? And maybe enough of those shaky deals will hold up to make your gamble pay off, right … RIGHT?
These are all, of course, terrible ways to play poker and terrible ways to make loans.
Every semi-serious poker player understands the basic rules of probability – that the outcomes of previous hands have no statistical relation to what will happen in the present hand (or in the hands after that.) The “Tilt Guy” is attempting to defy those rules and it almost always ends badly for him.
The best lenders know to rely on the data, and to ignore their lizard brain. The lizard brain falls for patterns that don’t exist, and attributes skill or risk to random wins and losses. Bankers that are letting their lizard brain call the shots often say things like ““Remember that hotel deal from a few years back? We’re NEVER doing another one.”
The data and analytics will tell the best lenders which deals and structures are right. We’ve met lots of bankers who claim they are successful because they follow a “gut instinct.” In our experience, they eventually find heartburn, either in the form of unforeseen risk or missed opportunities.
While there are lots of other traits that are important to being a successful lender, most of them will fall into one of those three buckets – empathy, communication and quantitative>qualitative. The one thing you might have noticed is missing, though, is “technical knowledge.” Don’t lenders need to understand credit risk, and the basics of how to structure a deal?
Absolutely, but we have also found that those skills don’t make a great lender. They’re table stakes – you have to have them in order to even play the game. Most banks we talk to are concerned about how to train the next generation of lenders, but the focus is almost always on credit training. Instead it should be on building relationships and adding value for customers.
Teach lenders those skills, and big production will follow.
Developing the Traits: The Saga of Dave and Mike
Back in Dallas’ early banking days, he worked with a couple of “star” lenders.
One was a guy named Dave, who was a big-producing CRE lender. The other, Mike, was a younger guy who happened to work for Dave. The two had very different approaches – Dave was aggressive and an extrovert while Mike was quiet and more steady – but both got results. Eventually they both left for greener pastures, and that is where the story gets really interesting.
Mike jumped to a competing bank, and was able to take a surprisingly big chunk of his book of business with him. Over the last decade Mike has been promoted multiple times, and is now successfully leading and growing a new market for the bank.
Dave went to work for a smaller bank, becoming the CLO and a member of the executive management team. When Dave’s old customers found they couldn’t replicate their previous relationship with Dave at his new bank, they declined to follow him. Dave clashed with the management style of his new employers, and in just over a year, he was out of a job.
By any metric, both Dave and Mike had been very good lenders who seemed poised for big things. They each possessed the three big traits that we see in great lenders. And yet, only one achieved “alpha lender” status.
Why did their career paths diverge? Because only Mike’s bank took an active role in further developing those key traits.
Here are a few ways your bank can produce its own share of “Mikes.”
Put Empathy Into Action
Yes, some people simply have more empathy woven into their DNA, and we should seek out those types to be our lenders. Hiring absolutely matters. But, a great lender has to be able to do more than just feel empathetic toward their borrowers; they have to be able to act on that empathy. This requires a specific environment at the bank that can serve as the foundation for differentiated service and better relationships.
Culture change is admittedly VERY hard, especially in large, complex organizations like banks. However, we often see commercial loan teams that develop their own distinct “mini-culture” that is quite different from the rest of the bank. Leaders of loan teams can absolutely create these mini-cultures, and should strive for an environment that includes these core elements:
A Customer-Centric Approach
This doesn’t mean “the customer is always right” and that we just bend to their demands. That is generally a bad idea in commercial lending. Instead this means that all interactions are designed from the customer backwards. We set up the entire process so that we can understand their needs, be flexible enough to meet them when possible, and respond quickly and efficiently.
Lenders Have Both Authority and Accountability
In order to be responsive to their customers, lenders must have the authority to make decisions. Obviously lenders should not have full autonomy in approving their own credits, but they should have the ability to make some basic decisions. This includes things such as loan structures, pricing, and renewal negotiations. For this to work, lenders must have clear guidelines and accountability for their results.
When banks get this right, they help lenders build deep, value-added relationships with their borrowers.
Lenders are too often kept in the dark about the big-picture strategy of the bank. Why are loan goals set where they are? Which loan types fit best with the balance sheet? If lenders are expected to always act in the best interest of the organization, it’s vital that they have a better understanding of where the bank is headed and how their contribution fits.
Having an open and ongoing dialogue with customers is essential for great lenders. However, very few banks actually train on these skills. If you mention “lender training” to bankers, they universally think of credit training. Yes, lenders need to understand the basics of credit in order to know the difference between a good deal and a bad one, and how to structure a deal that best fits the borrower’s needs. But credit skills are, again, really just table stakes. We’ve seen plenty of folks with a great credit background who are terrible lenders.
To be able to communicate with customers, lenders also need an understanding of asset liability management. They must understand the why and the how behind the pricing differences for various structures. We have seen lenders be far more successful in selling floating rates or prepayment penalties when they understand the circumstances in which those structures matter most to pricing, and can properly explain that to their customers.
This falls into negotiating, which again, most banks ignore in training. Your lenders are negotiating millions of dollars in transactions for your most profitable and risky products. Why not get them formal training in negotiating a deal?
In addition, lenders need to be able to communicate deal progress to their borrowers. What steps still need to be completed? How long will it take? And how can the lender help shepherd the deal through all of those steps so that closing happens when it is supposed to? Lenders should be able to answer all of those questions, which means dedicated training on “how the sausage is made.”
Improve Your Lenders’ Toolbox
Finally, lenders need to be able to overcome their “lizard brain” and make sound decisions based on data. These decisions include everything from how and where to prospect to where to look for likely credit problems in the existing portfolio. In short, lenders need to know what constitutes a “good deal” for the bank, and spend their time chasing those instead of pursuing deals that won’t really move the needle.
In order to do this, though, lenders need better tools. We often ask the question, “Do your lenders have better tools for playing fantasy football than servicing their customers?” Most banks admit that their lenders primarily use tools that are designed to “say no” to deals.
Risk management is important, but your lenders also need tools that help them “say yes” to deals and generate revenue. They need sales tools to help them prospect, price, and service their customers. Unfortunately, most walk into meetings with customers armed with nothing to help but a pen and a legal pad.
Dave and Mike: Where Are They Now?
As you can see, with the right culture, training and tools, the bank can have a great impact on the traits that make a great lender. Going back to Dave and Mike, those three things made all the difference in the outcomes.
Dave landed at a bank with an “old school” approach to banking, where lenders had no authority to serve customers, no training other than basic credit, and no tools outside of being able to look up customer balances on the core system.
Mike landed at a bank that was the polar opposite. The loan group put customers at the center of every decision, and they invested in the training and tools to develop great lenders. It certainly worked for Mike, and as we saw from the data on the profitability of Alpha Lenders, these are investments with a huge ROI.